I am no macro maven, and know very little about what is really going on in the Chinese economy, but the price action of Chinese equities for the last few years has been downright disgusting relative to almost ever other equity market in the world! Throughout the financial crisis in the U.S. we heard a lot of strategists suggest that emerging markets like the China had the potential to “De-Couple” from the problems in the west. Looking at the chart of Chinese GDP from 2007 to Q3 2013 you can see that China saw a fairly dramatic hit in the throws of the crisis as did most developed economies, but a fairly substantial bounce back (centrally orchestrated) only to start trending back towards the crisis lows.
Economic data in China for the last 6 months had been looking a tad better until a recent soft patch, but most would agree at least by taking the temperature of global equities that a “hard landing” is off the table, but are Chinese equities telling a different story?
Patrick Chovanec, China expert and Chief Strategist at Silvercrest Asset Management, earlier this week discussed the worrying nature of spikes in Chinese money market rates in a WSJ blog post:
“The underlying problem here is bad debt, a growing amount of bad debt being rolled over.” What’s happening is the bad debt is eating up any new credit that could go toward growth, which is leading to a continuing squeeze on credit.
There was a similar crunch this summer, he noted (indeed, we had him on the show talking about it), and the solution then was the same thing: rolling over the debt. Every time the PBOC tries to take away the proverbial punch bowl, the system seizes up, and the bank is forced to pump in new money, he says.
The large debt overhang has hindered health growth in Chinese-related markets for more than 2 years now. Industrial commodities and their related stocks, equity markets tied to China (like Brazil), and commodity currencies like the Aussie Dollar and the Canadian dollar have been flashing warning signs about China. But the global impact has been relatively contained.
The valuation differential between emerging market stocks and developed market stocks (particularly in the U.S.) has not mattered. We wrote about the valuation gap between similar multinational businesses in EEM vs. in SPY in August, and that gap has since widened. Who knows when it turns, but odds are getting better by the day that EEM outperforms SPY over a long-term timeframe.
In the meantime, psychology and technicals surrounding EEM are terrible, and Chinese systemic risk adds to such fears. EEM puts continue to show up on our most-traded Too Many Options screens, as they did yesterday again. It’s a favored way for portfolio managers to get protection to the macro risk, and hang on to their best stocks in the meantime. Somehow, it never works out so cleanly though.