China: No Bursting Bubble, Buy The Banks

August 03, 2015

Secondly, fears of a China property bubble have now receded. As we have argued, widely advertised crashes (as it was in the last few years) have a habit of not showing up. And, unlike America’s property boom, China’s was financed in large part through state-run banks, as opposed to a private banking system.

In a command-style economy, will China really allow their banks to go bust? Unlikely. Investors will have to wait for China’s “Minsky moment.” But success in stabilizing property markets should bolster confidence in bank asset quality and future profitability.

Thirdly, recent stock market declines have not been driven by any policy tightening. Rather, significant monetary easing by Chinese monetary authorities has steepened the yield curve. That’s a boon to banks, which become increasingly profitable when the spread between short and long rates widens.

To be sure, China’s micromanagement of the stock market has been somewhat shocking. The grab bag of policy measures designed to support the stock market run counter to Beijing’s aim of creating a liberalized financial system where market forces are given a larger role. That’s a big step backward. Further developments will need to be monitored.

However, heavy-handed intervention is hardly unique to China. The world’s monetary authorities have been underwriting risk and a virtuous cycle of higher asset prices for some time now. America has a “Yellen put,” the eurozone has a “Draghi put” and, not to be left out, China now has a “Xi Jinping put.” The era of market manipulation continues.

And if investors are looking for a transparent and well-functioning market, one exists. It’s called Hong Kong. Many of these listed shares have been indiscriminately sold off during the mainland’s slump. FXI provides exposure to the largest and most liquid Chinese companies listed in Hong Kong (with more than 50 percent allocation to financials). Or for a more concentrated approach, CHIX’s underlying constituents primarily comprise Hong Kong-listed shares, American depository receipts and global deposit receipts.

Conclusions

Confucius once said that "everything has beauty, but not everyone sees it." China may be today’s case in point. Investors have incredible difficulty making the leap that the paradigm is changing. Views of the future tend to rely heavily on the recent past.

Looking ahead, there is much work to do if China is to fulfill its strategic global ambitions (and stabilize the banking sector). Financial reform and opening China’s capital account will be a volatile process. Cyclical head winds are indeed present, and prophecies of doom will continue to plague China.

Yet this is the time to be investing in an unloved sector. In the coming decade, the world will have to reckon with China not as a rapidly growing export nation, but as a burgeoning financial power. The practical challenge will be to identify a broader range of both Chinese and non-Chinese assets that will be rerated due to China’s global objectives.

Tactical asset allocators should start with an overweight to the banks.


Tyler Mordy, president and co-chief investment officer of Hahn Investment Stewards, is a recognized innovator in the design and application of global macro ETF managed portfolios. He is widely interviewed by the financial media for his global investment strategy views, as well as ETF trends. CNBC has called him one of the “best independent ETF experts.” At the time of this writing, the author, along with his firm's clients, own FXI and ASHR.


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