Stay out of Chinese stocks for now
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MoneyWeek Editor
John Stepek Jul 14, 2009
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Britain's banks are never far from the firing line at the moment. And rightly so.
On the one hand, we hear that the taxpayers' holding in semi-nationalised banks Lloyds and RBS is currently showing a paper loss of nearly £11bn, and that it could take years to offload these stakes. On the other, we hear that the banking sector is also raking it in, with mortgage profit margins at their highest levels in more than 20 years.
There's nothing wrong with this – lending against assets that are losing value is a risky business, and banks should charge highly for it. However, it does suggest that – despite all the 'stimulus' being pumped into the economy - there's little chance of a new property bubble inflating to save us all briefly from recession.
But one country is having much more luck with its own stimulus package. In fact, it may be working too well...
China's stimulus package seems to be working...
Like everywhere else in the world, China has been pumping money into its economy in an attempt to fend off recession. Unlike everywhere else, China's stimulus package actually seems to be having an effect. Whether that's a good thing or not is another question – but we'll get to that in a moment.
The Shanghai stock market is up by around 60% since the start of the year. Chinese banks have issued 7.3 trillion yuan (£663bn) in loans so far this year, and doubled the amount they handed out between May and June, reports The Telegraph. There are signs of another property bubble building – last month saw the record-breaking sale of a plot of land in Beijing's central business district.
And now the bosses in Beijing are starting to get a bit worried. The amount that the banks are dishing out "now far exceeds the government's four trillion yuan fiscal stimulus package".
...but this may not be as good as it seems
They're right to be worried. The trouble is – as we've all been reminded over the past couple of years – the more pressure you put on banks to lend money, the less careful they become about who they lend it to.
Over here in Britain, and over in the US, it was a combination of cheap money, dodgy accounting, moral hazard, and competitive pressure that led to companies writing home loans for anyone who walked in off the street. In China, there might be a bit more involvement from central planners, but the result is the same.
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And the Chinese banking system is hardly what you'd describe as transparent or sturdy. S&P analyst Qiang Lao reckons that bad debts will increase this year. The banking system can cope with that, he says, but things may get worse over the next two to three years if the economic slump continues.
Certainly, it doesn't look as though China's export sector is going to bounce back any time soon. Exports are still falling year on year, and with the West still gripped by rising unemployment and falling property prices, consumers are unlikely to kick up their heels and go out bingeing again in the near future.
Now China's reliance on exports is often over-exaggerated, as my colleague Cris Sholto Heaton has pointed out in the past (Why Asia doesn't need exports to grow), but even so, the country has a lot of work to do to improve domestic consumption. The last thing it needs is for a huge property bubble to inflate and then pop, leaving consumers in the same dire condition as their American and British counterparts.
Bond investors are already making it clear that they are concerned about the economy frothing over. In the past week or so, the Chinese government has on three occasions failed to sell as many bonds as it had hoped. As John Foley points out on Breakingviews.com, this isn't hugely surprising, given that the 1.25% maximum yield is a pretty feeble attraction, compared to the soaring stock market. And with banks pumping out cash like there's no tomorrow, investors are also concerned about potential inflation rendering that fixed income worthless.
Why you should avoid investing in China for now
So it's perhaps no surprise that the central bank is starting to hint that the lending boom can't continue. That seems sensible, but like any economic decision, it's not going to be pain free. As soon as the markets get a hint that lending policy is going to tighten up, all the bubble-chasers and speculators head for the hills, suggesting that the stock market will be vulnerable, certainly in the short term.
All in all, we'd avoid investing in China right now. For a more interesting – and less well-known - emerging market alternative, check out Cris's latest edition of MoneyWeek Asia. If you don't already receive it, you can sign up here for his weekly email - free.
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