Wandering China

An East/West pulse of China's fourth rise from down under.

How to prepare for a China crash [The Age]


The Age (readership est. 600k, established 1854 in Victoria, Australia, owned by Fairfax Media): China Bears preparing for the Chinese slowdown by remixing investment baskets.

It was forseen that continued double digit growth on the back of three decades was not sustainable. In any case, lest is forgetten, the mantra for this running five-year plan isn’t to get quick rich anymore, readjusting China’s sights for the longer term. And that means those wishing to make money from China’s return as a global leader need to make informed adjustments too.

In November last year we published a boldly titled special report, The Coming China Crash. It made the argument that Chinese growth was being driven by investment rather than consumption and that the situation bore a striking resemblance to that of Japan in the late 1980s. And we all know how that ended. Nathan Bell

– – –

How to prepare for a China crash
by Nathan Bell
Source – The Age, published September 24, 2012

For years, China was the flavour of the month. So popular were its attractions that the Rudd government had enough time to stitch together a new mining tax and the Gillard government to unstitch it. Yes, it’s been that long.

When faced with economic difficulties, the United States could first rely on Alan Greenspan to make money cheaper, and then on Ben Bernanke to make it free.

Australia had its very own “put” based on China. No matter what went wrong in Gondwanaland, the industrialisation of the world’s most populous nation would dig us out of a hole by paying us to dig more holes on its behalf.

All we had to worry about was a soaring currency that allowed us all to take cheap overseas holidays. When you’re living it up in Barcelona, really, where’s the problem?

The excitement this induced in the West quickly outpaced reality. In almost all industrialised nations, property rights and an independent legal system are central to the development process. Not in China – its path to prosperity remains a vast experiment.

The fall in the price of iron ore – by more than 50 per cent in the past year – has been the point about which the China Put turns, an excuse for all those long-standing concerns about Chinese growth to gain some air.

The change in tone in media coverage has been quite something. The China bears have always been there but when iron ore was changing hands at $US180 a tonne, no one wanted to listen. Now you can’t hear anyone else.

Take Societe Generale’s Albert Edwards, a well-known China bear. He has reassuringly called Australia, leveraged to China and with a banking system heavily dependent on external investment, a “CDO-squared”.

Collateralised debt obligations (CDOs), you may remember, were those nasty little things that blew up the global banking system.

More worrying are the comments and stats emerging from inside China. According to a report in The Financial Times, some of the biggest China bears are Chinese economists, who have nothing to gain from talking things down.

At a conference in Tianjin one said, “I believe China is going to experience a very serious economic downturn and I think it has already started. The government is trying now to stabilise the economy but the instruments they have are very limited. If it can’t turn things around then I expect huge and widespread social unrest.”

The FT went on to quote, again anonymously, a Western fund manager: “After what I’ve heard I’m really worried now about being the dumb foreigner sitting across the negotiating table from the locals who are packed and ready to run to the airport.”

Who would have thought 18 months ago that China would sound like Saigon circa 1975?

In November last year we published a boldly titled special report, The Coming China Crash. It made the argument that Chinese growth was being driven by investment rather than consumption and that the situation bore a striking resemblance to that of Japan in the late 1980s. And we all know how that ended.

Thus far, it appears the China crisis is running to script. The report examined the top 20 stocks for their exposure to a Chinese crash (you can get access to the report using the free trial links below).

If you haven’t yet adjusted your portfolio to that possibility, there’s still time for you to do so. Here are a few pointers.

The big four banks are all indirectly exposed to a China slowdown, with their need to source funds from the wholesale money market their Achilles heel.

If funds dried up as they did in 2008, especially at a time when unemployment and mortgage stress was increasing, property values could tumble. That may quickly see a sharp increase in bad loans and pressure on capital adequacy ratios, which is where a banking crisis tends to start.

Despite banks being a big beneficiary of the flight to safety, with share prices and dividends increasing, keep them to no more than 10 per cent of your portfolio.

If you do own any of the hybrids, include them in your portfolio calculations. If there is a bank crisis, they might convert to equity anyway.

The same rules apply to insurers, such as QBE Insurance, AMP and Suncorp, and fund managers such as Perpetual and Platinum Asset Management. Keep your portfolio allocation to each sector to 10 per cent and restrict your allocation to the financial sector, which includes banks, insurers and fund managers, to no more than 25 per cent in total.

Many of the stocks in the top 20, including Westfield Group, Woolworths, CSL, Telstra and Wesfarmers have performed exceptionally well in the past year.

The growing appetite for high-yield stocks and the rush to safety has seen a number of them rise substantially. CSL, Woolies and Westfield all had Buys on them but all are now Holds. Don’t rush out and load up on them.

In contrast, Fortescue Metals has been severely affected by the plunging iron ore price, with BHP Billiton and Rio Tinto less affected, reflecting their diverse operations and cheaper mining costs.

With the iron ore price now about $100 a tonne, just half its peak, margins are being squeezed. Rio and BHP are still making plenty of money and BHP in particular is starting to look attractive but there’s no need to rush in.

With higher costs and lots of debt, Fortescue may continue to struggle. The recent rebound offers some time to get out. It’s an Avoid.

If you haven’t yet prepared for a Chinese slowdown, don’t leave it until it’s too late. It’s possible that a huge Chinese stimulus package, as we saw in 2009, may delay the day of reckoning but it’s not something on which to rely.

Companies deeply exposed to China, especially those that are highly leveraged like Fortescue, will struggle to get through this period intact. There’s no need to rely on a kleptocracy to bail you out when you can do it yourself. To find out how, follow the links below and look out for our special report available in late October providing you with a brand new portfolio built to withstand and profit from a potential China-induced malaise.

Nathan Bell is research director at Intelligent Investor

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Filed under: Australia, Charm Offensive, Chinese Model, Domestic Growth, Economics, Finance, Government & Policy, Influence, Infrastructure, Media, Politics, Public Diplomacy, Resources, Soft Power, Strategy, The Age, The Chinese Identity, The construction of Chinese and Non-Chinese identities, Trade, , , , , , , ,

2 Responses

  1. Godfree says:

    The underlying assumption of this piece is that China’s economy is structured like ours. It is not.
    Its foundations, structure, management, and goals are utterly different.
    The only people I’m aware of who’ve come to grips with this phenomenon are two Australian macro-analysts. For an introduction to their work, start here and follow the links…
    http://inpraiseofchina.blogspot.com/2011/01/chinas-productivity-miracle.html

    • ferylbob says:

      I’d have to agree. Perhaps more targeted, the Han Chinese dynamic is essentially and largely about collective organisation to bandy up against cultural differences, from the fundamental unit of the family nucleus to state organisation. There is no original word for logic in the Chinese language for example, a dominant western modernist rationalist paradigm that only made headway in Chinese thought recently. The form and practice and getting things done were carried out with a wholly different sensibility. Your thoughts?

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