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He’s back. Hugh Hendry, the outspoken hedge fund manager best known for his bearish views on China and this jerky, homemade video of empty malls and deserted developments, has come out with a new letter to his investors after an 18 month absence.
China bulls will find few comforting words in it though. Quite simply, Hendry thinks China’s massive property bubble will burst in a spectacular fashion and become the focal point of the next financial crisis.
From Hendry’s letter:
It has long seemed to us to be the case that this economic crisis would start in the US and make its way to Europe. That has happened. However, we also think it will end in Asia.
This might be the year everyone else notices this; the year panic over Chinese economic growth comes to replace the market’s morbid fascination with the travails of the European continent and the year in which we see that the US is not giving way to China in terms of global economic leadership. There is a near consensus that China will supplant America this decade. We do not believe this. We are more bullish on US growth than most.
Hendry’s arguments are familiar enough. Real negative interest rates (interest rates minus inflation) on traditional bank deposits and few alternative investment options have prompted Chinese savers to plough their money into the property market. Soaring real estate prices in turn have prompted even more investors – many borrowing from unofficial or “underground” lenders – to speculate on real estate.
But with Beijing clamping down on the market to curb soaring house prices and inflation, Hendry say this game of “pass the parcel” is at an end.
All was well as long as China’s legions of risk takers could borrow…and then flip their purchases…America’s QE2 seems to have prodded the Chinese monetary authorities to remove the punchbowl.
Things are not much rosier on the government debt side of things. When the global financial crisis erupted in 2008, Beijing responded by ordering state-controlled banks to flood the economy with cash and local officials were told to ramp up investment to jump-start growth. The result was a surge in credit-fuelled investment, particularly in residential property. In cities across the country, the results can be seen in forests of half-built apartment blocks, stadiums and convention centres.
According to official figures from June, local government debts stood at Rmb10.7tn($1.7tn) at the end of 2010 "“ or about 27 per cent of China's gross domestic product. However, Victor Shih of Northwestern University argued on beyondbrics that this figure could be much higher, at between Rmb15.4tn and Rmb20.1tn, while Moody's said China's National Audit Office has underestimated the local government debt load by some Rmb3.5tn.
With many of the loans secured on the value of land prices, falling property property prices raise the question – how will local governments repay their debt?
The truth is that while many still think of China as being financial stable, the state’s finances are increasingly imperiled.
Hendry thinks China is unlikely to export its way out of the problem as the European sovereign debt crisis and the austerity measures imposed by European governments crimp the buying power of China’s largest export market.
What then for China’s exports?…Sell Treasuries? Unlikely…China purchases Treasuries so that it could run a trade surplus and create the estimated 80m plus domestic jobs that now service the overseas sector. But should it have to sell these same instruments in order to address is own ballooning fiscal deficits and explosive growth in sovereign debt (as net exports turn negative and domestic bubbles pop), the renminbi (despite the economy’s poor fundamentals) could have to rise (as dollars were sold and yuan repatriated). The export sector would then be utterly annihilated.
It seems to me then that they would have little option but to keep their Treasuries and absorb the private sector’s escalating debts a la Japan….I am very pessimistic on the Chinese authorities’ grounds for manoeuvre. This makes me fearful of the future value of the renminbi.
It also means that when we look to at where the next market crisis will come from, we should be looking to China. There is a near consensus that China will supplant America this decade. We do not believe this.
Those taking big bets on several more years of rapid Chinese investment growth are vulnerable to big losses.
Grim stuff.
But should Hendry’s words be taken with a grain of salt? Afterall, he is running a ‘China short’ fund that’s made up of short positions against highly cyclical Japanese corporate credits that have high exposure to Chinese demand. So isn’t it in his interest to talk down China?
Should investors instead be taking their lead from Anthony Bolton, who this month said he still saw great value in many Chinese equities and that he would remain at the helm of Fidelity's China Special Situations trust for at least another two years?
So far it’s been Hendry 1, Bolton 0. While Hendry’s short China fund was up 52 per cent as of the end of November last year, compared to a loss of 4.3 per cent for his average peer, Bolton’s China Special Situations trust saw its shares fall 20.3 per cent from its April 2010 launch to end-November last year. Its net asset value was down 21.0 per cent in the same period.
Interestingly, while Hendry is bearish on China and Bric countries that are dependent on Chinese growth (i.e Eike Batista’s iron ore and port projects), he is bullish on US growth. But surely if China collapses as he seems to think it will, then surely that will have a knock on effect on US industries (car makers, diaper and fizzy drinks peddlers, etc) that have come to depend on China as an engine of growth?
But perhaps that’s a subject for another newsletter.
Betting big on generics
The beyondbrics file
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