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Some See Possible Credit Crunch for China

The traditional greeting for the Lunar New holiday celebration going on in China, Gong Xi Fa Cai in Mandarin, can be literally translated as “Congratulations, Get Rich.” Some experts say the

The traditional greeting for the Lunar New holiday celebration going on in China, Gong Xi Fa Cai in Mandarin, can be literally translated as “Congratulations, Get Rich.” Some experts say the getting rich part may be harder for investors in coming

One pessimist is the Hong Kong-based head of research at a Chinese-owned brokerage. I’ve referred to him in previous stories as “Dr. Gloom” because he doesn’t want to be identified by name and because cautious view of the state of the Chinese economy – a view that proved much more valid than the sunny market consensus through 2011 and most of 2012.

Last week he sent me an email recommending “a good piece on China” from global investment management firm GMO LLC. He said the stance taken by the article “is not much different from mine …, only in more depth.”

The GMO white paper says that although Chinese stock valuations look solid, “China scares us because it looks like a bubble economy.”

Feeding the Dragon: Why China’s Credit System Looks Vulnerable, which can be found here, states: “Our fears have not stopped us from buying emerging stocks, or indeed some Chinese stocks, but they have tempered our positions relative to what they would be if we were not concerned about the bubbly aspects of China.”

The article provides a sobering laundry list of concerns about China’s credit
system. They include:

*Excessive credit growth (combined with an epic real estate boom)

*An increase in bank off-balance-sheet exposures (masking a rise in leverage), and

*Widespread financial fraud and corruption (from fake valuations on collateral to
mis-selling of financial products)

GMO looks at each concern in detail and in an historical perspective.

Dr. Gloom said in his email his list is similar, adding over-supplies in many industries and lack of innovation.

It should be noted that experts have warned about major flaws in China’s economic machine since market reforms started to take hold in the early 1980s, but still, even with the recent dip in GDP growth, China chugs along with high-single-digit expansion. Many forecasts for 2013 are for GDP growth of slightly more than 8%. And being overly pessimistic about China might lead investors to miss a good  opportunity to make money, like the 24.4% surge in the Hang Seng Index in Hong Kong from September 5 last year to January 30.

However, the wide range and depth of concerns raised by GMO and Dr. Gloom deserve consideration.

The good doctor said the recent rebound in economic growth has partly been driven
by infrastructure investment and already duplicate and useless projects are
emerging in some cities. Meanwhile China’s decade-old plan to shift to consumption-driven growth remains stalled.

Economic statistics show an economic rebound in China, he said, but the reliability of the figures is questionable and company-level growth has seen only limited improvement.

He thinks China may avoid a banking crisis. But he said, “Slower growth in the next 3-5 years will be inevitable, (with the) worst case scenario: China will follow the (slow growth) path of Japan.”

He said the “ideal solution” is for China’s new leaders to take bold actions to correct deep economic problems, possibly leading to a downturn but promising good prospects in three to five years.

With no significant changes, Dr. Gloom said, growth will be slow and the stock market will range trade, although the range may be wide enough to fool people into thinking a bull or bear market is returning.

He said if the bubble bursts there is “a lot of downside,” with the Shanghai Composite Index possibly plunging to 1,500 from its current level of 2,432.  End


Hong Kong Blue Chips: +198, +0.8%, to 23,413, 2-14-13, Hang Seng Index

Chinese Stocks in Hong Kong: +172, +1.5%, to 11,823, 2-14-13, HSCE Index

Shanghai Stocks: +14, +0.6%, to 2,432, 2-8-13, Shanghai Composite Index. Closed for holiday

Chinese Stocks in the U.S.: -5.2, 386.4, 2-7-13, Bank of New York Mellon, ADR Index-China

Insight: Hong Kong opened higher after being closed for a long weekend celebrating the Lunar New Year. Blue chips rose 250 points at one time, but gains eroded in slow, cautious trading without any signals from Mainland markets, which remain closed. Chinese properties rebounded from recent weakness: China Overseas Land (CAOVY) +2.5%. KGI Research

Quotable: “Trading volume of the local bourse is likely to be low after the Lunar New Year holiday break next week, as the Mainland stock markets would close for the whole week. The Hang Seng Index is expected to hold grounds above the 23,000 level, as buying spree would gradually pick up steam, as the March earnings reporting season approaches.” BEA Securities. 2-13-13

Chinese Company to Watch: “SINOPEC CORP (SNP). Plans to use proceeds to … acquire parent company upstream, which will … boost margin. Prospective P/E of 8x.” KGI Asia. 2-14-13

Brokerages and analysts cited here have disclaimers on their websites emphasizing their statements are for information only. They do not endorse my blog, and I don’t endorse them.

For a list of Chinese companies sold in the U.S. and information on each company, click here.