Trouble in the Land of Opportunity?

“Calling the Trend” Column, by George Leong, B.Comm.

Many of you know how bullish I have been on China. I continue to feel that way, but, at the same time, also remind you to be careful.

China is viewed as the land of opportunity for investors looking for added growth and a boost to their overall portfolio returns. The returns can often be spectacular as we saw in 2009; but also keep in mind that investing in Chinese stocks listed on U.S. and Canadian exchanges can add high risk. Nevertheless, while this is the case, the opportunity for above-average gains more than compensates for the added risk. The key is diversification in your portfolio across domestic and foreign stocks, and across sectors and market caps.

In 2009, China easily outperformed U.S. indices; yet, here we are coming to the end of January and it is the opposite. The benchmark Shanghai Composite Index (SCI), the largest exchange in Asia based on trading value, is struggling. It is down 7.88% as of January 26, far worse than U.S. indices.

There are currently some problems brewing in China that are pressuring Chinese stocks. There is increased fear surfacing in China of a bubble and overheating on news that Chinese banks were ordered to halt lending for the remainder of the January due to excessive credit. So far, four major Chinese banks have halted lending as per government demand. The fear is that the slowing Chinese economy could impact global economies. The Chinese government suggested that it would tighten monetary policy to avoid overheating.

Take a look at the growth. The target GDP growth set by the government in 2010 is eight percent, but the majority of economists feel that the country could grow at nearly nine percent. In December, China’s exports grew 17.7% year-over-year, beating estimates and representing the first positive reading in 14 months.

The Chinese Academy of Social Sciences (CASS) is warning of extreme inflation if the country does not reduce monetary expansion, according to the “South China Morning Post.”

The World Economic Forum (WEF) suggests that China has a greater than 20% chance of a serious economic slowdown this year, during which the WEF pegs losses at $250 billion to $1.0 trillion. The easy credit growth in China is partly blamed for the situation. I have talked about the rise of debts on credit cards in the previous issue and clearly it has become a major concern.

A major area of concern is the country’s booming real estate sector. Think what happened to the U.S. housing market and you’ll understand the concern. Prices in 70 large and mid-sized cities in China surged 7.8% year-over-year in December, according to the “Financial Times.” The rise was attributed to easy credit, so banks have now been instructed to stop paying commissions to sales agents for generating mortgage business.

As we move forward, keep a careful eye on China, as whispers about a potential bubble in China’s credit and/or real estate market seem more realistic if the government fails to rein back growth a bit.