Finance: Focus on China when investing

PHUKET: China’s stock market is imploding and that’s not only shaking confidence in the country, it’s also impacting global financial markets. However, investors need to keep in mind that over the past 15 years, the Chinese stock market has actually experienced both sharp rises and steep falls, with the last crash occurring in 2007.

The market then largely moved sideways until about a year ago when the government and state-controlled media began talking it up as they began pro-market reforms. Since there are few productive places for Chinese savers to put their money to work beyond the property market, which the government has also tried to cool, many new and inexperienced retail investors entered the stock market.

The problems started at the beginning of this year when economic growth slowed dramatically and the effort to reform financial markets turned into an effort to create a wealth effect to prop up faltering economic growth.

There were actually several catalysts that finally burst the Chinese stock market bubble, and these included MSCI not including China in their emerging market indices, which means there is no big influx of foreign institutional investing; the easing of monetary policy, but no fresh money entering the stock market; and heavy margin financing that caused small margin calls to lead to increasingly larger share price falls. There were also expectations that the government would never allow the stock market to fall since it had talked up the markets.

Most foreign investors and funds own shares or have exposure to Chinese stocks trading on foreign exchanges or the Hong Kong Stock Exchange, but not the sinking Shanghai Stock Exchange, which the government is attempting to prop up as local investors are taking heavy losses.

As draconian policy interventions aimed at shoring up share prices have largely failed or only had a short-lived effect, the widely held belief that China’s government and policy makers are in complete control of the economy, and can achieve whatever outcomes they desire, has been badly shaken. In other words, there are still limits to autocratic command and control economies.

China’s government is also still dominated by autocratic political leaders schooled in Maoism who are neither economists nor technocrats – meaning they can’t necessarily grasp the free market policy concepts needed to run a modern economy. This makes badly needed long-term structural reforms difficult to consider or implement.

The stock market crash can still spill over into the general Chinese economy to impact multinational companies with big operations there, but many companies do not break out their sales and profits for the country – making it difficult for investors to quantify any direct damage or exposure.

Aside from Chinese stocks and China ETFs, consumer stocks with heavy exposure to China like Yum! Brand Incorporated (NYSE: YUM); casino stocks with Macau operations like Las Vegas Sands Corporation (NYSE: LVS); and commodities, with one example being copper prices having now neared six-year lows; could continue to see bigger headwinds.

However, not all stocks with exposure to China will be impacted the same way, with a good example being Boeing Co (NYSE: BA), which has long term, as much as 20-year contracts, to sell aircraft or spare parts to China, but shares of Caterpillar (NYSE: CAT), which sells both mining and construction equipment that’s also used in big infrastructure projects that the Chinese love to undertake, have recently hit a 52-week low.

The bottom line is that the Chinese economy is second in size to the US and is still very dynamic and growing – meaning foreign investors cannot ignore the direct and indirect investment opportunities there. Moreover, any investor with a well-diversified portfolio should see a limited fallout from any Chinese stock market crash.

Don Freeman, BSME is president of Freeman Capital Management, a registered investment adviser with the US Securities Exchange Commission (SEC), based in Phuket. He has over 15 years of experience working with expatriates, specializing in portfolio management, US tax preparation, financial planning and UK pension transfers. Don can be reached at 089-970 5795 or email: freemancapital@gmail.com.

— Don Freeman