Shanghai Tunes: Is China now a problem? - The Honest Truth By Ajit Dayal
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Investing in India - Honest Truth by Ajit Dayal
Shanghai Tunes: Is China now a problem? A  A  A
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20 AUGUST 2009


When the US sneezes, goes the saying, the world catches a cold.
Actually, make that pneumonia.

The way the world had frozen and went into cold storage in the year 2008 and the first few months of this year put all fears of global warming behind us. In fact, it was the reported sighting of green shoots and the warm weather that makes the ice thaw which led to the bounce in global stock markets since March, 2009.

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Between July 31, 2007 (just before the Bear Stearns funds went bust) and March 2009, global stock markets as depicted by the MSCI World Index (MXWD in Graph 1) had lost nearly -60% in US Dollars. China (SHCOMP) and India (SENSEX) had done a little better - and all markets have seen a good recovery since then. But, till August 19th, 2009 the markets are still deeply in negative territory. India is down -19%; China down -29%, and the MSCI World Index is down -28% when measured in US Dollars.

Graph 1: Global thaw as China and India warm to consumption.
Global thaw as China and India warm to consumption
Source: Bloomberg

Part of the reason for this bounce - in stocks and in our mood - was the fact that governments and central banks were seen to be winning the battle against depression and a collapse in global trade.

The reverse economic engines
Also, China was seen as the champion of what I refer to as a reverse economic engine. The country which provided the low cost goods that fuelled the global consumption boom was now itself a consumer. China would purchase the higher priced and more skilled goods that the western world had to offer. From Boeing aircraft to GE nuclear plants to Caterpillar excavators to Siemens rail systems: China was a buyer.

Furthermore, China was also buying as much raw material as it could, wherever it could. India and other emerging economies are also seen as add-ons to this reverse economic engine story but China dominates by its sheer size.

China's USD 524 billion stimulus package is legendary stuff now and proof of how governments can seize the bull by the horn and turn adversary into opportunity. A friend told me once that in Chinese, the word for crisis is the same as the word for opportunity.

So, on a trip to Shanghai in May, I was dazzled by all the bright lights of the marvellous sky scrapers and the high energy of bustling Shanghai. But, in meetings with some companies and research analysts, I was puzzled by what seemed like a contradiction.

China had a huge export business.
The USA and the western world were slowing down and consumption was falling rapidly.
There were reports of job losses to the tune of 20 million because of the closure of the export businesses - from soft toys to socks to electronics.
True, China had this USD 524 billion stimulus plan which was spurring rural consumption and investment in infrastructure - about 15% of GDP to be spent over 2 years (by contrast, India's stimulus package is 3%). Clearly a positive for China.

But bank lending was up some 100% compared to the previous year, 2008.

So, was the price of real estate rising in Shanghai and were the stock markets moving so rapidly because:
  1. the earnings of companies were rebounding with the stimulus package? Loss of profits from exports was offset by growth in profits from domestic sales. This meant a real economic boom where employees get higher salaries and increase consumption?
  2. money was finding its way from banks to companies to stock markets? Pretty normal in situations where bank lending grows so rapidly - and we have seen that in India many times in the past. With so many factories closed in China and a case of oversupply, I could not imagine a case of companies making investments in manufacturing capacity
  3. of a combination of the above two?
Not easy to get answers to these sort of questions in China.
But I did return troubled and not entirely convinced about the China boom as reflected by the surge in prices of property and stocks.

The Chinese turn American?
The representative of a steel company from Latin America which had not exported steel to China since 2004 but had renewed exports this year told me: We think China is buying all the steel it would normally have consumed in 2010 (next year), in this current year 2009. In 2010, they may buy all the steel they were originally to consume in 2011. But how long can they keep this up? How long can they bring tomorrow's consumption today?

Long enough.
Or at least as long as people don't dig deep and ask the right questions.

China is doing as country, what Americans did as a people.
But with a difference.

Most Americans could not buy their new car or new home. But "cheap" money allowed them to finance what they could not afford to buy.

China is buying what it should buy tomorrow, today.
Just like the Americans did.
The huge difference is that China can afford to pay for it.

It may also be a sneaky way of converting its paper horde of USD into real goods and services. Steel and iron ore lying in idle and empty Chinese shipyards is worth a lot more than US Treasury paper. And the rents on warehousing space and shipping costs have declined by over 50% from their peaks.

That is the good news: the reverse engine theory seems intact and China's buying is more real than the buying of the Americans.

The bad news - or fear - remains: did much of the money find its way into stock market speculation? And what happens as the China stock market tanks further? The Shanghai Index has already lost -20% from its peak - the classic definition of a "bear market".

Graph 2: China moves from a panda to a bear.
China moves from a panda to a bear
Source: Bloomberg

Graph 3: India: needs a Bollywood choreographer to get its moves right.
India: needs a Bollywood choreographer to get its moves right
Source: Bloomberg

If the financial stock market bubble deflates in China - there will be losses for sure. And the usual cycle will start.

Retail investors go bust, brokers that they owed money to go bust, the banks who lend the brokers money go bust, some international group will have lent some Chinese group some money and that international group will be in trouble, the central bank of that country will step in....you get the picture.

It happened in Mexico in December 1994.
Then the Asian Banking Crisis in 1997.
Then LTCM and the Russian default in 1998.
Then the tech bubble in 2000.
Then this home loan and sub-prime credit bubble the world is still coping with.

Economically, China may be an engine but if its financial markets are in trouble, the global flows of capital will again be under threat.
Just as they were in September 2008 after Lehman declared bankruptcy.

So the short term capital is reacting violently, in fear of tomorrow.

The Indian stock market - and others globally - are dancing to Shanghai's tunes.
And more dances to go.
With the rain playing truant, the drought is another theme we are dancing to in India.

Maybe the choreographers at Bollywood can help us find a way to smoothen these pretty jarring steps.

But till they figure that out, hang on to your seat belts - turbulence ahead - but stay with the allocation in Table 1 below and stay calm through the ride.

Suggested allocation in Quantum Mutual Funds (after keeping safe money aside)
Quantum Long Term Equity Fund Quantum Gold Fund
(NSE symbol: QGOLDHALF)
Quantum Liquid Fund
Why you
should own
it:
An investment for the future and an opportunity to profit from the long term economic growth in India A hedge against a global financial crisis and an "insurance" for your portfolio Cash in hand for any emergency uses but should get better returns than a savings account in a bank
Suggested allocation 80% 20% Keep aside money to meet your expenses for 6 months to 2 years

Disclaimer: Past performance may or may not be sustained in the future. Mutual Fund investments are subject to market risks, fluctuation in NAV's and uncertainty of dividend distributions. Please read offer documents of the relevant schemes carefully before making any investments. Click here for the detailed risk factors and statutory information"



Note: The Honest Truth is authored by Ajit Dayal. Ajit is a Director at Quantum Advisors Pvt Ltd and Quantum Asset Management Company Pvt Ltd.. Views expressed in this article are entirely those of the author and may not be regarded as views of the Quantum Mutual Fund or Quantum Asset Management Company Private Limited. To write to Ajit, please click here.


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7 Responses to "Shanghai Tunes: Is China now a problem?"

Ashit Kothi

Aug 29, 2009

To Comment on Is China now a problem? is like recognising Elephant blindfolded. One needs lots of info on where that $524 Billion of stimulus package has gone into ? into Real Estate, Stocks or in procuring hard assets like metals and minerals and preparing oneself for the next onslaught on world trade. We might see China not just as a cheap product exporter or importer of advanced technology and services but a major international trading player much to the dislike to Japanese and American Trading Giants.

If at all China becomes a problem it will be much more devastating than US. While US was world's Consumer China was world's Producer turning into Consumer.

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Z

Aug 28, 2009

'A' seems like a competitor of quantum and A's critics seem like dayal's employees except for param who is a blogger. nonetheless dayal's views are sound and regardless of whether the article is belated or not for a lot of retail investors it will still prove useful. the experts of course don't need the honest truth, they can pioneer their own columns.

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ashim

Aug 24, 2009

It is a fact that most of the stocks (long-term included) recommended by you since the last 2 or 3 years have nose-dived even after the holding period. And the worst scenariois when you downgrade a previous recommendation with a new one ... suggesting buying of stocks at a lower rate when one is already invested at a higher rate. Honest truth should have the honesty to admit this fact when presenting new recommendations. eg Lakshmi Foods & Energy.

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Param

Aug 21, 2009

To A:
The author only indicates he visited China in May - it does not say he discovered the truth in May. Comments on the article might be more relevant than comments on the author...

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Noel

Aug 20, 2009

Dear A,

Bang on! hit the nail on the head. Funnily this is the truth about "Honest Truth" i.e being wiser after the event. Come on Ajit, give me a break. Its a fact that your funds are underperforming, so admit it. Look at your mid-cap recommendations from 2006-2007, e,g cranes software, its languishing way below your recommend buy price, another one is Taj GVK, RelCom, DLF etc. I can see you are just waiting for another crash on dalal street, and it may come sooner rather than later, yet it cannot absolve you of that fact that your fund and recommendations are underperforming !!...No hard feelings buddy, just the honest truth......thanks Noel

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X

Aug 20, 2009

i completely agree with what is written by A, you should be sherlock holmes infact.

i have a question for A:
why should we say that to anyone who is providing free service, if you were paying a price for honest truth it made sense in you asking this, you can only read or ignore.

most analyst today read ahead of you on the internet and write, it is in any case a delayed commentary.

as an anonymous phrase says : the one who travels a lot his own house is always in trouble.


for a troubled house we recommend (free of cost) chintan baithak's.

they are on at a lot of places and expelling is a continous process.

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A

Aug 20, 2009

Dear Mr. Dayal,
If you visited China in May and "discovered" the "honest truth", then why did you wait till August to share it?
While your commentary is good, it is a bit late - after the whole world knows about it.
This is like giving the commentary of a cricket match, only 3 months after it was played!
Honest truth delivered on more timely basis would be more valuable than stale news that the whole world knows.
Cheers,
A

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