• Bernhardt Wealth Management

The Bear in China

While US investors are coping with bear market returns, Chinese stock investors have been experiencing an outright fire sale. The Hang Seng China Enterprises Index lost a total of 9% of its value near the end of October, falling to its lowest level since 2008. Chinese companies listed on US exchanges fared even worse, dropping 21% in a single day.

Ordinarily, these huge dips represent an overreaction and a big buying opportunity, but among funds that are investing in China, there is little appetite to move back into the market. The market drop represents a negative response among business leaders to the events at China’s twice-a-decade party congress, where President Xi Jinping stacked the country’s leadership ranks with allies, clearing away opposition and opening the door for the party to exert greater state control over Chinese markets and the Chinese economy overall.

The Chinese government’s interference in deciding which companies succeed and which ones fail, added to its habit of propping up unprofitable enterprises run by government cronies, make it very difficult to accurately predict future company earnings and growth, which are the principal drivers that build stock value. Thus, the move by President Xi to consolidate control, not only politically and economically, but also financially, may bode ill for the business climate in the world’s most populous country, not to mention its effect on the desire of investors outside China.

Adding to the negative outlook is an initiative by the US and its global allies (Europe, Canada, Japan, South Korea, and Australia) to limit shipments of chip production equipment to China, cutting semiconductor technology out of China. Given the importance of technology to maintaining the pace of development, this could present China with another significant obstacle.

And that’s not all. Piling on to the gloomy expectations about China’s future is the huge debt crisis in the country’s real estate sector, most prominently led by the huge Chinese development company Evergrande, whose finances are a few rungs below bankruptcy at this point, even though the company is too big a part of the Chinese economy to be allowed to fail. People who have bought homes from the real estate giant are now refusing to pay their mortgages due to chronic construction delays. In the US, structural problems like these would be easily handled, but real estate and property sectors account for a quarter of China’s total gross domestic product. Evergrande and the Kaisa and Shimao development companies collectively are carrying liabilities in excess of $300 billion, and no bailout is in sight.

At Bernhardt Wealth Management, we believe that diversifying investments among well-run international companies, as well as domestic enterprises, is part of creating a well-diversified portfolio and increasing the investor’s chances of long-term success. It’s also important to remember, however, that the total allocation of such a portfolio to the equities of any single country—even one as large as China—should not represent an overweighted exposure. In the context of a properly diversified portfolio, the current difficulties faced by the Chinese financial markets, while worthy of attention, are not likely to threaten long-term performance.

To learn more, click here to read our article, “Global Events and Your Investments.”

Buen Camino!

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