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Last week, Moody’s downgraded its credit rating on Chinese debt. So what?
Since then, the talking heads on CNBC have been out in full force claiming that China is doomed to default on its growing debts.
But this tempest in a teacup shouldn’t worry you one bit. In fact, the Moody’s downgrade could be a wonderful contrarian buy signal for Chinese shares. Here’s why…
Granted, China’s debts have ballooned in recent years. In fact, total Chinese household and corporate debt now stands at 220% of GDP. It has expanded by $19 trillion over the past eight years alone.
It’s easy to see how these “scary” headline numbers could be used to frighten investors away, especially when those figures get taken completely out of context from what’s actually happening in China today.
First, financial stability is actually improving in China right now, and it has been steadily on the upswing since the end of last year. The Bloomberg China Financial Stability Index (see chart below) is clearly in an uptrend again, after bottoming in the fourth quarter of last year. The trend has been boosted by gains in Chinese stocks, tighter monetary conditions and a slowdown in capital outflows from China.
In other words, the worst is over already and Moody’s is late to the party … again!
Second, another reason so-called experts get it wrong with China is that they forget how the Red Dragon funds the vast majority of its debt internally. State-run companies within China hold most government and corporate debt.
That’s why a credit downgrade isn’t about to trigger a wave of bond selling, because Beijing simply won’t allow it to happen.
China’s total external debt – that is, held by investors outside of China – is just a tiny 13% of GDP, a very low level compared to many other nations. For example, Japan’s external debt equals 74% of its GDP while in the U.S. it’s 97%! Meanwhile, foreigners own just 3% of China’s debt.
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Third, still if you want to pick on China for its growing liabilities, then at least be fair enough to look at the asset side of its financial statement. The fact is, China saves almost 45% of GDP, far and away the highest savings rate of any large economy on earth.
This means China doesn’t need to borrow from foreigners, it can fund its economic growth internally. It’s self-sufficient, so a credit rating downgrade won’t phase China’s financial markets in the slightest.
And sure enough, the iShares China Large-Cap ETF (FXI), which is the largest ETF tracking Chinese stocks, is up 18% year-to-date, far ahead of the 6.5% gain for the Dow so far this year.
Bottom line: Chinese stocks have enjoyed nice gains so far this year, and members of my Real Wealth Report have profited nicely thanks to FXI and several other timely recommendations.
That said, I wouldn’t be a bit surprised to see a pullback at some point soon, probably triggered by a correction in U.S. stocks. But I would view any pullback as a great buying opportunity in China, regardless of Moody’s downgrade.
Remember, the U.S. suffered a credit-rating downgrade in 2011, which the talking heads on CNBC said was the beginning of the end for our stock market. The reality is, the Dow has more than doubled in value since then.
Good investing,
Mike Burnick
Mike Burnick, with 30 years of professional investment experience, is the Executive Director for The Edelson Institute, where he is the editor of Real Wealth Report, Gold Mining Millionaire, and E-Wave Trader. Mike has been a Registered Investment Adviser and portfolio manager responsible for the day-to-day operations of a mutual fund. He also served as Director of Research for Weiss Capital Management, where he assisted with trading and asset-allocation responsibilities for a $5 million ETF portfolio.
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I doubt the rating agencies since the 2007-09 blowup as they have pretty much rendered themselves useless.
Thanks for your positive analysis.
Just an idea to add.
Debt is considered as life-threatening burden. However, it’s only one side figure of double entry accounting. They rarely say about asset which is always bigger than debt. Asset=Debt+Capital.
Why not think about non-financial debt which should be cleared by history, culture or morality?
Time to develope a “Double-double entry” booking system.
Don’t forget that the Chinese people aren’t as spoiled as Americans and Europeans and willing to study and work harder.That alone is a reason to be positive on China and Asia.
mike
many of us have repeatedly asked you to talk about gold. I bought your news stories to know about gold and larry always talked about gold. if he passed the mantle to you, why in the world are you avoiding talking about gold?
Have you never heard of China’s Wealth Management Product (WMP) being offered to savers through the banks? They pay 7% and are offered as an alternative when opening a savings account that pays 2% interest, so are frequently selected at opening an account. The funds raised under WMP are used to build apartments and commercial construction to keep employment marching. Unfortunately, the supply of apartments being built to keep workers busy is exceeding demand, turning WMP into a giant Ponzi scheme where interest payments come from new accounts instead of from sales.
It is utterly ridiculous for credit rating agencies to assess any sovereign government. These governments have the power to create the nations money supply. They are not USERS of money created elsewhere. So in their own currency they can buy any and every debt due. They can never accidentally go broke in their own currency. So they won’t. So the rating is useless, like tits on a bull.