Jim Chanos has caused something of a stir in the last couple of weeks or so by proclaiming that China is a bubble. He called the real estate market Dubai 1000 times over. Below is the CNBC video and here is a link for a further recap.
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 unpaid 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.