This week, the cover story in US financial paper Barron’s warns readers to expect a hard landing in China.
It covers all the bases. China has relied too much on exports (not a viable model when your customers in the US and Europe have no money) and infrastructure building (not viable when you’ve built too much of it already). So now it faces a property crash, and tighter credit, just at a time when it’s trying to become a consumer-driven economy.
That’s a tough task for anyone to tackle. It’s even tougher for a country burdened with vested interests who would rather keep the state-owned enterprises in control than let the private sector breathe. Oh, and on top of that, there’s a change of leadership to cope with.
However, it doesn’t add anything new to the story that MoneyWeek readers wouldn’t already have picked up from our various China covers over the last couple of years. (Read this piece from June 2011 for a full rundown of the bear case: China is heading for a fall – here’s what it means for you).
And that got me thinking. If the China story is only now hitting the mainstream, and there’s not much new to add to it – well, maybe it’s time to have another look at Chinese stocks…
The commodity supercycle can’t be saved by Chinese stimulus
China’s problems have become pretty obvious to most people. Being bearish on China is no longer a minority sport. And to be fair, the market has gone some way to adjusting its expectations. Commodity prices have come off, as have mining shares. Meanwhile, the Chinese stock market has fallen close to lows not seen since early 2009.
Now, knee-jerk contrarianism is just as stupid as mindless herd-following. Just because significant numbers of people start waking up to a story, doesn’t mean that it’s over. Things can always get worse than anyone expects.
But it never hurts to re-examine the thought processes behind your investments. And with ‘sell China’ stories cropping up everywhere, now seems an opportune time to do it.
The first part of the story is this: China’s investment boom can’t continue. Local governments are running out of money because they committed too much to projects that won’t pay for themselves. Meanwhile, property prices are falling, so developers won’t be able to build more.
Basically, China has built too much. It can’t continue at this rate. And given that China accounts for the lion’s share of commodity consumption, that means commodity prices will fall. In turn, that’s bad news for miners.
I don’t disagree with any of this argument. And I don’t see it changing. In fact, I think it’ll get worse. The bull argument for the commodity supercycle to continue now boils down to this: that China’s leaders will panic, commit to another massive stimulus package, and its appetite for commodities will be rekindled.
Tax cuts are better than stimulus packages
I don’t buy that. As the always-insightful Andy Xie points out on Caixin, another stimulus package would actually be a disaster. “Cutting interest rates stimulates the economy by encouraging borrowing.” However, businesses and local governments are at their limit. “Their main collateral, land, is depreciating. Cutting interest rates alone won’t ignite borrowing from them.”
Households might be able to take on more debt, says Xie. But that would just shift the problem to them. And to reflate the property market would take an awful lot of stimulus. So much, that it would lead to inflation.
That’s the last thing the government wants. Also, given that social harmony is the thing that China’s leaders apparently care about most, bailing out householders at the expense of non-householders would be a mistake. Just look at what it’s done to social harmony in this country.
The (still) ridiculously high cost of housing is probably the most damaging economic problem still afflicting Britain. We think that’ll change, of course.
Anyway, back to China. In short, says Xie, the best thing the Chinese government can do is to let the property bubble burst. They can handle it. And if they need to start stimulating the economy, tax cuts would be the best bet.
Of course, there’s no guarantee that this is the path they’ll take. And while stimulus might not be big enough to save the commodity supercycle, any sign of rate cutting or money printing would probably give the Chinese market a bit of a jolt higher.
That’s one reason why Swiss private bank Lombard Odier, which has been bearish on Chinese stocks for the past two years, recently suggested it might be time to buy in – cautiously.
The group acknowledges that “demographic challenges and a massively centrally planned economy are big hurdles to a smooth transition” not helped by the need for developed economies to “reduce their imports of Chinese goods”. But it also notes that “the price to ten-year average earnings stands 22% below its historical average, close to February 2009 lows”.
I have to say, I’m not convinced. I can see how any ‘stimulus’ package might lead to a bounce. In fact, the money printing probably doesn’t even have to come from China to give its market a bit of a lift. A bout of printing from the Federal Reserve might do it.
But for me this is still too much of a punt. Putting money into the Chinese market feels like taking a short-term bet on what the Chinese government will do next, rather than a long-term investment in an economy that can only get better. There are still far too many things that could go seriously wrong for my liking, and far too little clarity.
In short, in terms of bargain hunting, I’d feel more comfortable putting money into Europe than China just now – we’ve discussed this in various recent issues of MoneyWeek: The 17 investments our experts would buy now (if you would like to become a subscriber, you can subscribe to MoneyWeek magazine). However, that’s not to say that there aren’t any individual Chinese stocks that might be worth considering. If you want to keep an eye on where the best emerging market investments are, sign up for our free MoneyWeek Asia email.
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