I have been warning of this for nearly a decade as I watched various Australian investment legends blow themselves up in China, including Kerr Neilsen and Hamish Douglass. Investing into China is foolish for one simple reason: the sovereign risk is off the chart.
This is not an academic measure of risk. Nor is it bias nor loyalty to western markets. It’s simply a fact that has been played out time and again because China has seriously malformed macroeconomic settings that lead it to consistently and repeatedly crush foreign investors.
These problems include:
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- The impossible trinity in which macro managers can only control two of three variables in an open capital account, interest rates and capital flows. This leads China to compulsive episodes of capital account opening and closure that means capital is at constant risk of being trapped behind a hostile border armed by violent communists.
- Its development model is dangerously unbalanced leading to boom and bust cycles in construction and commodities which turn its currency to be a pro-cyclical dog, turn its stock market into the plaything of the moods of a paranoid politburo, and afflict debt markets with unpredictable bouts of moral hazard and withdrawal thereof.
- Don’t be fooled that you can find protection or relief in ETFs. They are generally saturated with large SOEs and miss the best parts of Chinese assets anyway.
There are other problems, not least being Cold War 2.0, but that’s the nub of it. So, when I read material such this on the weekend I cringe:
Australian fund managers have warned their investors to maintain exposure to the world’s second-largest equity market, and even state-owned enterprises, after the US government expanded its blacklist of Chinese companies.
What horseshit. The China market is a trap that has caught many investors much smarter than you or I. Niall Ferguson wraps it with his usual panache:
As it happens, I turned bullish on Chinese stocks a month ago and that has begun to play out. The regulatory crackdowns on tech are largely over and yields are falling, which usually triggers higher stocks these days.
But I still wouldn’t invest in it because I don’t know, and never will, the mood swings of the dictator.