Is now the time to China-proof your portfolio?

July 18, 2011

AsĀ  the People’s Republic is entering a “whack-a-mole” phase — where unrest and economic pressures keep rearing its head in different places — it makes it hard to predict whether or not China’s volatility over a strained economy will result in a major meltdown in Chinese stocks. The country has weathered storms before and bounced back.

But if the U.S. defaults on its debt, China will acutely feel the pain, since it’s banked more than $1 trillion in U.S. Treasuries. That’s why you need to ask yourself: Is now the time to “China-proof” your portfolio? While a holding of more than 25 percent of any investment could be hazardous to your wealth, China could be a perilous investment if the country unravels. Here are four cautionary scenarios:

Slow or no growth in the U.S. and Europe
With Eurozone and U.S. debt and housing woes dominating the global financial headlines, you have to ask what impact this will have on China’s export-based economy. Since North America and Europe are China’s biggest customers, this will hurt the expansion of the most populous country in the world. Any high-flying growth stock there will suffer there. A “double-dip” recession is still possible in the U.S. and abroad.

A banking bubble
This has long concerned China watchers and fund manager James Chanos, who said he became bearish in 2009. Are banks honestly reporting their earnings in The People’s Republic? A good question.

A real-estate bubble
Any economy running at a double-digit clip is prone to this malady. The demand for building seems to be slowing down, but will prices turn south?

The currency dilemma
China holds more than $2 trillion in foreign exchange reserves, most of that in dollars. Since its currency is pegged to the buck, it could be hurt even more if the U.S. economy sags — or Congress defaults on U.S. debt. China has also been funding everything from American tax cuts to the running of two wars for the U.S. through its aggressive buying of Treasury debt. How long this continues is anyone’s guess. But when China is able to, it might start dumping dollars.

Keep in mind that China’s political relationship with the U.S. is often tenuous. U.S. economists and policymakers have repeatedly called for China to let its currency float higher, which the Chinese have embraced as warmly as a wet noodle. And nothing is guaranteed if trade or military tensions flare.

“So far China’s financing of the U.S. has come on exceedingly generous terms — and has been remarkably stable,” write Brad Setser and Arpana Pandey for the Council on Foreign Relations.

“Creating a more financially balanced global economy will be difficult as long as China’s government continues to peg tightly to the dollar and add large sums to its foreign assets,” they add.

There are also some justified concerns about whether the auditing of the books of Chinese public companies has been transparent; U.S. analysts are skeptical on earnings numbers, particularly in “reverse merger” stocks.

Reducing your exposure to China may be a good idea. A balanced emerging markets fund like iShares MSCI Emerging Markets Index ETF is a good start. The fund only has about 17 percent of its holdings in Chinese stocks and includes Brazil, India, Russia and other developing countries.

If you really want to go bearish on China, a major speculative bet would be the Direxion Daily China Bear 3X Shares ETF. The leveraged fund moves 300-percent in the opposite direction of a basket of Chinese stocks. It’s definitely not a play for conservative, buy-and-hold investors.

Whatever you do, spread your money out among the world’s largest and developing economies. In the interim, you might want to pay attention to what’s happening in China and double-check your portfolio.

8 comments

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Just about the least useful article on investing I’ve started to read in recent years. Not worth finishing.

Posted by Eideard | Report as abusive

So ya the RMB, is relatively pegged to the dollar. And Ya, if the US dollar took a hit, China would feel it more than anyone, not because of its invests in the dollar, but because its valuation against the dollar would be substantially strained, IE The US would pass the buck on inflation to their Chinese partners. 5-6% is nothing compared to what would happen if the US does not take care of their financial/political brainfart before Aug 2nd.

On the plus side, any parallel devaluation would benefit China in exports to everyone who is not the US.

But lets stay focused. The global economy is so interlinked now that any economic failure in the US, Europe or ASEAN, would cause global recession.

So how do you Earthproof your portfolio? Move to Mars.

Posted by kc10man | Report as abusive

This article is silly. Treasuries are the LAST thing that would go, there would be Armageddon-type cuts in the US first with mass unemployment, etc. And even if the Treasuries were defaulted on, china would take a huge hit, but the hit to the ourselves would be insane as borrowing costs would rise, inflation would soar, and theoretically anarchy could ensue. China would actually be the best bet relatively speaking as they could afford another stimulus package and have room for domestic consumption to rise.

Posted by mgunn | Report as abusive

China buys our corn and our debt which supports our economy. Defaulting on our best customer and largest creditor is a stupid theatrical trick by the Obama Administration. Alongside that, leaving 3 FTA (free trade agreeements) on the desk for 2 and a half years is equally stupid. Is it November yet? Open our Ag markets, cap our debt, repeal Obamacare, and get out of the Middle East. Tea anyone:?

Posted by iowafarm | Report as abusive

China buys our corn and our debt which supports our economy. Defaulting on our best customer and largest creditor is a stupid theatrical trick by the Obama Administration. Alongside that, leaving 3 FTA (free trade agreeements) on the desk for 2 and a half years is equally stupid. Is it November yet? Open our Ag markets, cap our debt, repeal Obamacare, and get out of the Middle East. Tea anyone:?

Posted by iowafarm | Report as abusive

China and the emerging economies are much better positioned to successfully endure the next (impending) phase of the global financial crisis. The developed economies are terribly positioned. Aim your investments accordingly.

All the experts keep trumpeting how the U.S. is able to endure all the rough rides because the dollar is the global reserve currency. That’s a two-edged sword. In a crisis of sufficient rocking of the dollar – which the impending one just might be – the U.S. has a hell of a lot farther to fall.

Who’s going to hold onto their dollars when the U.S. soon loses its AAA rating and starts defaulting on its debt? Look at how feverishly Central Banks are spending dollars to buy gold. What’s that tell you about the dollar????

Posted by NukerDoggie | Report as abusive

Why kept on repeating the stale tactics of shorties and punters that China got lots of fraud in accounting and practices. Don’t you realise that US is the greatest fraudest in the world. Name the big cases of discovered fraud and most share a common source – US. Its only the blogs and Western news that China got lots of fraud.

Posted by 1ert | Report as abusive

1ert; because Chinese media is not credible. It chooses what to call fraud and what to ignore. Either way there is no such local government fraud in the US like there is in China. Wuhan, Chongqing and Mianyang are great examples. How does a mayor manage to get 2 billion USD in bribes before getting caught? Where else but corrupt China could that be possible. I believe the saying there is, “its not cheating unless you get caught”.

Posted by kc10man | Report as abusive