Tuesday, March 5, 2024

Mind on Money: China’s financial situation a cause for concern

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China. There is clearly no other nation on earth eliciting so much attention from the American political establishment. The rhetoric from the American Right is that China is a dangerous emerging world military power focused on ending western dominance in the Pacific and American prosperity if it can. The less noisy, but still prolific intellectual musings from the American Left are that China represents a distorted caricature of socialism and central planning which has dangerously devolved into global corporatism run amuck. The common thread between the spectrums is of course, danger. China is a danger.

As investors, however, in an ideal world, we are tasked with looking through the rhetoric of the political pundits in an attempt to develop assumptions based not on agenda or demagoguery, but rather accurate observation and analysis. As investors, we don’t seek the propagation of a global political adversary to rouse our constituents, we simply seek to earn or protect capital, and this, in my opinion, makes our objectives much more straight forward. For us, it’s about the money.

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Well, on the money front, China has gotten a lot of attention over the past few weeks, and quite frankly, none of it has been good. I don’t have the space to go over all the details here, but to catch everyone up quickly, every time we belly ache about the absurd $34 trillion American national debt, if we want to immediately make ourselves feel better, we need merely cast our gaze to the Far East. The scale of China’s debt is impossible to compare to the U.S., simply because the Chinese situation is so alarmingly worse.

A recent Bloomberg analysis put China’s public debt-to-GDP ratio at 286% (the U.S. is around 120%), and according to recent reports from the IMF this doesn’t include “off balance sheet,” or hidden, debt embedded with regional or local governments. In addition, Chinese households have borrowed heavily to invest in real estate, and after creating a property bubble, real estate prices in the nation are in the process of collapsing, with some market experts predicting values declining as high as 50%. Not good, not good at all.

On the forefront of this real estate market disaster is a development company called Evergrande. Evergrande is China’s third largest real estate firm and has raised capital from Chinese investors and banks in a variety of debt instruments. Last week, a Hong Kong court ordered the liquidation of Evergrande. The company had stopped paying its debts in 2021, and now some estimates I’ve seen put likely losses on Evergrande debt at 98 cents on the dollar.

The potential contagion risk throughout the Chinese financial system from such an event is hard to overstate. In response, this week several Chinese credit rating agencies announced a credit downgrade of the Chinese government itself. The Chinese government reacted to the downgrade quickly, by fining the rating agencies as well as some of their senior executives personally. So essentially, at a time when accurate financial analysis of the Chinese economy is most vital, the government there has made producing said analysis much more difficult and perhaps even illegal. What a mess.

When I look at the Chinese financial and investment landscape, I feel like I’m watching an airliner bellowing thick smoke coming in for a landing. Not all is lost yet, but at the very least there seems to be a rough landing ahead, if not something worse.

I write about China about once a year. Going back almost 20 years now, from an investment perspective, I have never been a fan. For anyone with Chinese investment exposure either through Chinese companies listed in the U.S., through emerging markets mutual funds or perhaps even through funds focused on China, I know it’s been a brutal ride as of late. I am more concerned however, about the implications of a potential Chinese financial crisis or even collapse on the world economy. So, unfortunately, we American investors will need to pay close attention to China in 2024 and 2025. Right now China may in fact be dangerous. Just not for the reasons peddled by the politicians.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stock investing includes risks, including fluctuating prices and loss of principal. No investment strategy can guarantee a profit or preserve against loss. Past performance is not a guarantee of future results. This material may contain forward looking statements; there are no guarantees that these outcomes will come to pass.

Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at marc.ruiz@oakpartners.com. Securities offered through LPL Financial, member FINRA/SIPC.

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