The China Bubble

Following the Great Recession of 2008, I believe the next big asset bubble to burst is going to occur in China.

The Chinese stock market includes multiple tiers and classifications of enterprise ownership. Currently, there are 3 major classifications of publicly traded shares: A shares, B shares and H shares. A shares are quoted in Renminbi and are only available for trade by the Chinese and select international institutional investors. Class B shares are quoted in in foreign currencies and are available on mainland exchanges including Shanghai and Shenzhen. Class B shares were historically available exclusively to foreigners; however, Chinese citizens are now able to invest via foreign currency exchange accounts. Class H shares are shares in mainland Chinese incorporated companies that are traded abroad including Hong Kong and other markets. Similarly, organizations in the United States deploy varying share classification strategies; an example of this being Berkshire Hathaway Class A and Class B shares with varying voter rights and market price. Unlike the Chinese, these shares are available globally and are exchanged primarily on US domestic exchanges. The problem with the Chinese structure is not necessarily rooted in its uniqueness, but in the fact that most enterprise is owned or sponsored by the state, resulting in a high demand environment which raises the share price level domestically and abroad, in addition to creating a unique arbitrage environment for institutions and Chinese investors. Unequivocally, the unique structure of the market and availability of ownership opportunities, have and will continue to result in a speculative investing environment.

Not only am I concerned about the market structure in China, but I also have my qualms pertaining to Chinese monetary policy and economic performance. In my opinion, the Chinese market revolves around the fact that the country employees such a high savings rate, nearly 50%, with relatively low interest rates, approximately 5.25%. While this may not seem like a big deal, particularly when comparing the U.S. target fed funds rate of .25% to the Chinese target; however, this is becoming a huge problem as Chinese citizens drive up public stock prices in their local markets above and beyond reasonable intrinsic valuations. When the expectation is set that you can “earn” a much higher yield with a riskier portfolio, people tend to listen up, and start moving their money into new alternatives. Some also argue that this low interest rate environment continues to perpetuate the Chinese protectionist policy pertaining to their core manufacturing and labor base, thus making their products more attractive in the short term.

At the end of the day, I really do believe that there is value to be had in China. If you find the right companies at the right price then go for it. Historically,I do not think there have been any developed nations that have grown over 9% in real GDP without having any bumps along the way. Again, if you intend to incorporate China into your portfolio make sure you know what you are buying and be proactive about monitoring your investment – – my recommendation is to proceed with caution.

Below are a few additional resources for reference.

Top China Banker Warns on Asset Bubble
China’s Unreal GDP

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