So is he right? Is he partially right? Is he totally wrong? There is no shortage of opinion and commentary. I tend to come at these things in somewhat of a different way than most of the things I read, hopefully it is useful.
China has almost as many moving parts as whatever the hell is going on with that traffic light pictured below. Typically I prefer simpler investment destinations but China is too important. For anyone new I sold my one China stock, one of the oil majors, in June 2007 which was a few months before the peak. I then bought back in when the Shanghai market had dropped 60% on the way to a 70% decline with China Mobile (CHL). I recently added a little more exposure via a themed ETF. CHL has not been a very good pick thus far but the ETF is working out ok (up a little) so far.
China has plenty of risk and obstacles that anyone who invests there should have some inkling of. There are issues that press now regarding lending growth, empty office towers, concerns over real estate speculation, the government buying goods (artificial demand), some worry about the statistics being fudged, should the yuan be allowed to appreciate it could hurt exports and so the entire economy (job loss and slower growth) and further down the road there will be a demographic problem.On the plus side the country has clearly become more important in the world economic order, has an enormous cash hoard, is spending on modernizing every aspect of infrastructure which makes the country smaller bringing a middle class lifestyle to the rural, poorer parts of the country. The spending on this stuff is going to happen even if the stock action is not linear. In fact it has been far from linear.
Another part of Chanos' argument is that bubbles are caused by excess credit. Loan growth has been troubling and the South China Morning Post recently reported that upaid credit card debt was up 126% in 2009 (this was reported in the South Morning China Post in late November but is no longer accessible) and we have this from Time Magazine noting that the average household in China saves 25% of disposable income.
This article opines no real estate bubble because down payment requirements are 30% for a primary residence and 50% for a second home. I don't know if there is a real estate bubble or not but a big down payment does not automatically mean people are not speculating. China has a different culture and different rules. If there is a bubble in real estate it would be naive to think it will be exactly like what happened in the US.
I think the use of the word bubble is actually useless. Slapping the correct label on it is less important than avoiding pain if there is to be any. This was the motivation that lead me to sell in June 2007. The Shanghai market peaked around 6100 and is now close to 3200. The Hang Seng topped out at 30,400 and is now around 22,000. And for good measure the Hang Seng Enterprises Index, aka the H share market, hit a high of 19,500 and is now in the twelves. As I have mentioned before the odds of a market going down a lot are less after it has gone down a lot.
The things Chanos worries about could absolutely come home to roost, things could deteriorate and asset values drop but some perspective on where the markets are is in order. I have been very consistent on the exposure I want which the modernization of the country that leads to the middle class lifestyle. This means no banks, no real estate, no exporters and no consumer discretionary. At some point maybe in the middle of the decade or a little later the steam behind the build up and out of the country will wane, this might be around the time that the demographic problems kick in, and I would think owning consumer staples and health providers would make sense at that point and really staples might make sense now but I favor the other part of the theme.
If Chanos turns out to be correct and we are not lucky enough to get out early then how much China you own will matter. If Chinese markets cut in half from here because of the fundamentals he is worried about then a lot of other markets including maybe the US could go down in sympathy but some of those other markets would be on firmer footing and come back quicker than China. I could see topping out around 5-6% of the portfolio in China so that if I am wrong and don't get out it won't ruin clients but if I'm correct then the exposure could add a lot to the overall portfolio.
22 comments:
Good post. Any thoughts on Hong Kong (how tightly correlated is it to the mainland and do u own any?)
Pundits can, and do, opine about bubbles everywhere, everyday. China? Gold? Bonds? Personally, I find them all dangerous to my investing health.
For my risk profile, in markets like China, I harvest profits regularly on the way up and use moving averages to get out on the way down.
In case you missed it, Roger, thestreet.com has an interesting article featuring CAGC, which marries the ag and China themes.
Good post, with implications beyond just China. Thanks!
Yes good post.
How early was Chanos in calling the other "bubbles"?
While "bubble" is way over used, I would not expect the term to go away.
The world has had the collapse and now we are trying to reinflate. I would not bet against central banks the world over right now.
Jeremy Grantham of GMO fame made this observation in his 3Q09 Market Commentary as well. Hard to tell given no audit or review of government numbers (either in China or, gasp, here).
i have no pure HK exposure. HK is a lot of RE companies which i dont want as opposed to chinese companies traded in HK which is just about everything (exaggeration). i am intrigued by HK exchanges as i do believe hk is a financial hub of grwoing importance
Anon 6:46 AM
H share companies are Mainland companies listed on the HK stock exchange.
A share market is a domestic (closed) market mostly so valuations should be compared to others.
Roger,
I am curious to understand why you would underweight banks, RE and consumer disc. Seems that emerging middle class gaining wealth will want one, their own house, and two, investments/investment products and three, ways to spend their income...
Thanks.
AI
i've been saying that for ages. that is where the greatest risk lies, IMO, it is not where money must be spent.
Roger,
HK has only one stock exchange (388.hk) and an excellent GARP play as long as China does not give the financial hub role to Shanghai. It is NOT cheap (25x EPS) but sometimes some of the best things in life don't come cheap.
BTW, apart from Chinese Nasdaq listed tech companies, almost all "chinese" companies that international investor invest in are HK listed.
AI
yes, i differentiated in my comment. actual HK companies as opposed to chinese companies listed there.
You probably know this but for those that don't - greather than 50%of the HK stock exchange companies are mainland chinese companies (by market cap).
BTW, you should be happy with CHL this week.
AI
China is a criminal enterprise. Corporate espionage eminating from China cost legitimate companies tens of billions of dollars annually and hundreds of thousands of jobs. German Intelligence estimated that Chinese espionage cost their economy over $50b and 30,000 jobs (annually). The US price is incalcuable.
We spend billions to counter this hacking and other data mining, which is another cost.
The US military documents tens of thousands of hacking incidents per DAY on sensitive facilities, including our Space Defense program.
The CIA estimates over one million Chinnese agents are working to some degree in espionage. Fact is, as one employer who was denuded of proprietary information by a Chinese green card worker, "I have to assume now that every Chinese worker I hire is odds on working to steal my work."
If this is racial profiling, so be it. What China needs, it steals.
Google Chinese Industrial espionage and you get over 110,000 hits.
T
T,
I do not want to dispute your comments, but protectionism leads to trade wars and a world wide recession.
The US spends billions on research and a lot of that at American Universities. Go to science or engineering department grad school. They are filled with 80 to 90 percent foreigners and all on various assistant ships. Some stay others go back home.
So we are paying to educate the best and brightest for China, India, etc. The research gets published in papers and books and information is given away for less than pennies on the dollar.
We give a lot away and people have been "stealing" technology for eons. Yes it is a problem but there are no easy answers. We need to produce goods cheaper than all competitors not just demonize the Chinese or whoever.
I understand you view, but China is on my mind, so pardon a few more lines.....
Beyond making a profit, I think that there are times when a spade has to be called a spade.
I agree that protectionism is not the ultimate answer. That said, gross abuse by China (and Russia, to be fair) through systemic and intense intelligence hacking and other blatant intel projects to steal proprietary information and turning contract law on its head when they see fit dwarfs anything we have seen, and it is getting worse. I don't have an answer to resolving the challenges this presents. I do know that we are not playing on a level playing field, and that the "cheaters" are winning.
Today companies like HP and Microsoft refused to support Google's stand against Chinese hacking and intelligence initiatives against Google's platforms. Their answer was that China is a wonderful market brimming with potential. That may be true. So was Hitler's Germany in the 30s and American companies and investors were sucked in at that time. Money before principles - yet again.
T
T,
Google is not altruistic. China went after gmail which highlighted that the net is vulnerable. Google wants everybody to believe the net and cloud computing is safe as can be and people should make the switch. It is not true, China has shown it is vulnerable, and you have said as much in the above posts.
China is not run by a Hitler. There is a group of ranking Communist party officers that run the show and keep it stable. OK so they do not care whether they beg, borrow, or steal technology I will give you that.
Protectionism is not the answer. We have to stop letting our guard down and protect our info and simply learn to out produce them. No one promised this would be easy.
Chinese espionage, sabotage and appropriation of intellectual property are very serious but can be counteracted in various ways without a fully protectionist trade policy. The same cannot be said for Chinese monetary and trade policies which disadvantage trading partners (e.g., http://tinyurl.com/ybw6m2x) and, in the current economic environment, must be considered predatory.
Barring substantive change in those policies including an appreciating Renminbi I think the odds of a trade war with China within the next few years will become substantial and that conflict will not simply be with the US either: Europe is harmed by China's currency manipulation as are many of China's trading partners in Asia and Latin America.
China's leaders have demonstrated considerable shrewdness so I doubt it will get that far before they slacken suppression of their currency but it will cost them growth in export volume so they must try to make a stronger transition to internal demand and consumption. China is growing a middle class by leaps and bounds (ironic since ours is shrinking) but it is not clear when it will be large enough to make compensate. JMO
RW,
can you be kind in given us the calculation on the growth of different segment of the population.
thanks,
jeff from milan, italy
Jeff,
A middle class in China (or many other emerging markets for that matter) is unlikely to be exactly akin to the middle class in the US or Europe given significant differences in relative costs of living as well as propensity to save (remember many of these countries have no social safety net) so estimates are all over the map with some very rosy projections -- e.g., http://tinyurl.com/yjdbwax -- and some far more skeptical; e.g., http://tinyurl.com/ygm7kos
A 2005 survey puts the number at about 11.9% of all employees in the country (http://tinyurl.com/yjcg8ff) but my own best guesstimate at the moment is below 10% a number that I freely confess is far less empirical but none-the-less grounded in the understanding that much of China is still rural and relatively poor, including areas immediately adjacent to urban centers where most of the more optimistic data comes from.
Whatever the number, it is my belief those with discretionary income in China will clamp down on consumption much more quickly than their Western counterparts should something like a trade war begin. FWIW
Have you folks thought for a second what the impact would be for rapid rising RMB versus the USD would do to longer term interest rate in the UST?
Imagine an annual appreciation of say 8%. What would China require the 10 year to yield? How much interest would you want from an investment that DEpreciates 8% a year? So either the 10 yr UST goes to 8% say and China will buy less from the UST market.
What would happend to the USD and cost of capital if the 10 year rose from ~4% to 8%? A nightmare - that is Julian Robertson is buying curve caps.
Bottom line, the US needs China (and others) to fund the US until its fiscal book is in order. (China needs to keep GDP >8% to keep the boat afloat so they have skin in the game too and exports are huge part of their economy).
In fact, the long part of the UST curve is that probably the largest risk for 2010!
Great post, Roger. Just one comment from myself; when I worked in China (just for the one year) I only saw a single credit card. There were none amongst all of my Chinese colleagues and just a flash of one used when I was out shopping.
RW,
Thank you for you answer and link.
Roger,
thanks for the post, you have an interesting view. Jim Chanon is also a smart cookye with lots of balls.
Anon 10:48
I am looking up curve caps. Some other think to learn. Thanks
Best,
Jeff from Milan, Italy
Jeff,
Curve cap info.
http://www.marketfolly.com/2009/09/julian-robertson-shifts-from-curve.html
Unfortunately, you probably need to be a professional investor to do most of the stuff. Alternatively, you can approximate the effect with LEAP puts on the TLT ETF.
AI
A leap to a 15 point delta from negative interest rates is a long tail event (Black Swan); i.e., even as insurance it is a bet; as a main play it makes so little sense it must be a head fake.
Negative interest rates (Taylor rule of thumb) means we are in a liquidity trap and that means that if China gives up on manipulating Renmimbi (unlikely) and sells US bonds as fast as it can-- there is no particular reason to believe Japan would join them but it doesn't matter -- then the more likely effect is China entering hyperinflation while US rates stabilize because China will, in effect, be joining the Fed in quantitative easing (QE).
Hint: If this doesn't make sense then remember that the economic world shifts in a liquidity trap, the Fed can no longer lower short interest rates so it is selling T-Bills and buying other assets: Lots of other assets but not foreign bonds because that would be doing for the dollar what China is doing for the Renminbi: Intervening by sterilizing other currencies to reduce appreciation in the domestic currency to gain competitive advantage.
NB: Level of QE also is the tell on the real Fed attitude toward a stronger dollar.
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