Forget Greece and Italy

Greece and Italy have been stealing economic headlines these days.

The media has been so focused on Greece and its pint-sized economy, that they have completely missed what should really be headlining world economic news…the slowdown of the world’s second-largest economy.

China’s government-induced GDP growth and red-hot housing market have both stalled.  Ironically, the government itself caused the slowdown, as it introduced prudent anti-bubble measures throughout the year.  Such measures were an unfortunate necessity: without them, inflation was turning rampant.  But now the slowdown may turn out to be just as devastating.  And, it seems that the largest companies in the world are well aware of what is coming.

Last week, Goldman Sachs sold $1.1 billion worth of its shares in Industrial and Commercial Bank of China (1398.HK).  This week, Bank of America announced it was selling the remainder of its shares in China Construction Bank (0939.HK) – $6.6 billion worth.

Today, the International Monetary Fund announced that Chinese banks could suffer “huge losses” on the very extreme case that credit shock, currency shock, and yield curve shocks were to occur together.  Interestingly, this “slim and rare occurrence” appears to already be starting.

The IMF's Jonathan Fiechter stated rather bluntly stated (as far as economist-speak goes) that "while the existing structure fosters high savings and high levels of liquidity, it also creates the risk of capital misallocation and formation of bubbles, especially in real estate." In other words, the current government’s financial policies force people to invest in real estate (since buying other asset classes in China is considered too risky), and, banks are lending too much to capital projects with no economic future (again based on government direction).

One could say that the Chinese economy is a centrally-controlled “our government knows better” economic marvel mess.

It is my advice - stated on several occasions previously - that you follow the lead of Morgan Stanley, Goldman Sachs, and Bank of America; that is, sell all but your very best Chinese holdings.

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See also:

China faces grim foreign trade outlook

China's property cost curbs to remain despite home price drop

China’s CCB Plays Down BofA Share Sale Impact

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Chinese Real Estate - Trip Report

Back from China…

First off, my impressions of the housing market in China - one of my primary reasons for visiting Shanghai.

Virtually everyone I spoke with admitted that the Chinese housing market is “expensive.” Yet, when asked if prices would drop, almost everyone answered with a blunt, “No.” When I inquired further (ex. “Why not?”) I received any one of a number of points exhibiting national or local pride. For example, that Shanghai is “a great place to live. Everyone wants to live here.” Or, that “the Chinese people have an entrepreneurial spirit, and so prices will keep going up.” And of course the real estate bubble classic: “There is a limited amount of space.”

Then I asked the follow-up question: “Are you planning on buying a home?” Only two out of dozens said “Yes.” A few said they already own one. Many added that they would buy “if they had enough money.” Therein lies the problem.

An inexpensive one-bedroom condo in Shanghai costs around $140,000 USD. An inexpensive two-bedroom condo costs around $205,000 USD. At the surface, this does not seem overly expensive; that is, not until one remembers the reality of Chinese prices.

For reference, I had a three-course meal and two beer at a local restaurant for $6 USD. A 30-minute subway ride costs 22 cents. Despite recent prosperity, the average salary in China is 1/7th that of the United States.

So, that one-bedroom condo is equivalent to $980,000 USD, while the two-bedroom is equivalent to $1.44 million. The average Chinese citizen has no hope of buying even a basic home (unless several generations come together to make a purchase), while wealthy Chinese continue to buy multiple homes on speculation. This cannot last.

When I first started writing about the Chinese housing bubble in January, the media was speaking about it as an “if.” Since then, reality has started to set in. The Chinese government is – to their credit – well aware of the situation, and continues to take steps to lessen the coming catastrophe.

Beginning Aug. 31st 2010, insurance companies will no longer be allowed to hold more than 10% of their assets in property development. The government is also instructing banks to tighten (again) the lending requirements for 3rd+ homebuyers in Beijing, Shanghai and Hangzhou. I would list all the bubble-busting measures the government has implemented previously, but it would be a long list.

As the Chinese and related Asian markets unravel, worldwide construction-related commodity prices (iron, coal, copper etc) should decline. In addition, one should obviously avoid Asian banks, development companies, and in fact any company with non-essential products or services that relies on China for a substantial part of its business.

Despite government measures and media warnings, the Chinese housing bubble remains steadfast: greed, pride, and cognitive dissonance are hard to break. But, as soon as the cracks appear, reality will set in with a vengeance. This bubble is BIG.
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See also: Sell the Chinese Market SHORT!
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"China's economy, in general, is in line with the government's macro-economic regulation and control."

Chinese Premier Wen Jiabao, July 18th 2010
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Sell the Chinese Market SHORT!

China has been making headlines recently with its amazing economic numbers.

Production, capacity, exports etc. are all up and the economy looks fantastic. It appears to be an economic marvel. Why then, would anyone of sound mind want to sell it short?

In fact, I believe that although the Chinese economy appears to be a roaring bull, it is in fact a bloated, sickly beast. And, the Chinese stock market may soon become of the single greatest short-selling opportunities in history. Here are five reasons why:

5) Social Security – The Chinese are gambling with their social security funds (worth $102 billion US), in the stock market and risky ventures. In 2009, the rate of return on social security investments was 16.1% (a ridiculously high rate for someone’s life savings), prompting Vice Premier Zhang Dejiang to call for “prudence” and “stronger management” (Xinhua, March 15th 2010).

4) Inflation – According to a recent poll (Xinhua, March 16th 2010), 51% of Chinese consumers feel that prices are “unacceptably high,” the highest percentage to say so since the survey began in 1999. Despite this already unacceptable level, inflation continues to escalate, with the Producer Price Index on track to rise 5.2% year on year.

3) Overcapacity – Like Japan after their economic collapse (where stimulus building included lining rivers with concrete blocks), the Chinese have built massive amounts of currently unusable infrastructure. The problem, according to many, was that once a project was announced it could not be cancelled, since any cancellation would cause local officials to lose face. So, projects went ahead, even if it was clear from the beginning that the capacity would not be used.

The result is unoccupied office blocks, newly built factories producing unwanted goods, and toll highways with no traffic. According to Government officials, the areas where the most overcapacity exists are iron and steel, cement, glass, coal chemical, solar energy materials, and wind power equipment – although 17 industries are listed in all.

2) The Housing Bubble – There is almost an unlimited number of things I could say about this one, but I will keep it simple. Housing prices are out of reach for most every Chinese citizen, and prices keep rising even while large housing projects remain virtually unoccupied (since so many units are owned by speculators). In Beijing, housing prices nearly doubled in 2009 alone. The Government’s attempts to stop the problem (including measures to prevent house flipping, and implementing lending restrictions to developers) have all failed.

The situation has gotten so severe that in March, China’s banking regulator simply said that Chinese banks "should not extend loans to home buyers who intend to use the money for speculative purposes," or unless they make a down payment of 40% or more and are charged higher interest rates to compensate for the risk (Xinhua, Mar 15th 2010). One recent headline (April 3rd 2010, Xinhua), simply read, "Collapse predicted, welcomed as housing prices continue to skyrocket."

1) The Chinese Government– The people of China are not Communist, but their Government is. China’s wonderful economic numbers are at best misleading, and at worse inaccurate or simply wrong. As worrisome as some of these facts are, the real ones are probably worse.
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Crisis: "Danger and opportunity" (literally translated from Chinese).

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Disclosure
Do not buy stocks, sell short, or take this or any other financial advice without doing your own analysis; including, but not limited to: reviewing business models, financial statements, management style and philosophy, recent developments, market macroeconomic analysis, and chart analysis. If you do not know how to do these things, you shouldn't be buying stocks in the first place. Seek the advice of professionals, as appropriate.

Chinese-Style Bao Ba

A quick and dirty definition of a bubble is when, a) everyone thinks that an asset is overpriced, but b) they want to buy it anyway.

This is precisely the situation in China, where, according to state news agency Xinhua, 86% of investors believe that a housing bubble has begun; yet 92% expect prices to remain steady or rise. On average, investors expect a gain of 4.4% per quarter, or 17.6% per year! Recent adjectives used to describe the Chinese housing market include “rocketing,” “sizzling,” “surging” and “searing.” In capital city Beijing, a 950 sq ft apartment costs the equivalent of $2.8 million dollars to an American (roughly 0.65 month’s salary per square foot). And if all that were not enough, the General Office of the State Council (Jan 16th) issued a report noting that “excessively rising house prices have recently emerged in some cities,” and recommended “restraining purchases for speculators and investors.” Ouch!

When something is this obvious, it’s painful to watch.

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“One clear indication of a bubble is the rapidity of the price rise. Although there are occasions when sharp increases in the price of individual stocks are justified, this has never been true of market sectors.” Jeremy Siegel