China debt default still biggest risk to investors
The Financial Post takes a weekly look at tools and strategies that will help make your investment decisions. This week: why China matters to your portfolio.
Iraq and Ukraine are dominating the headlines these days, but China continues to be the country that fund managers are most worried about and rightly so.
A survey released by Bank of America Merrill Lynch this week found that 36% of fund managers last month identified a debt default in China as the biggest current risk to investors, followed by asset bubbles (20%) and geopolitical instability (14%).
Most investors see any financial turmoil in China as a far-removed problem, but it is one with the potential to affect all portfolios.
“As the world’s second-largest economy, any significant reverse for China’s corporate sector could quickly spread to other countries,” ratings agency Standard & Poor’s said in a report this week.
China also remains the world’s top consumer of commodities, and has an impact on everything from copper to crude prices.
As a result, China has long been an extremely important economy for investors in Canada, where more than half of all publicly traded companies are tied to the resource sector. when they report second-quarter earnings in the next couple of months.
But the risks emanating from China extend well beyond commodities as the financial health of Chinese companies has recently come under increased scrutiny.
For example, the first default of a Chinese-issued corporate bond occurred this year when solar-equipment maker Shanghai
China also remains the world’s top consumer of commodities
One only has to look to the crash in iron-ore prices this year to see how rapidly bad news from China can hit global markets. Iron prices are down roughly 30% this year after China reported property construction plunged in the first quarter. It is expected the earnings of iron miners will begin to reflect the price crash Chaori Solar Energy Science & Technology Co. failed to make an interest payment on time. The default called attention to the issue of high leverage and shrinking cash flows among some Chinese companies.
“The combination of weakened financial profiles, slower economic growth, tighter ac- cess to borrowing, and higher interest rates pose a significant challenge to China’s corporate borrowers, especially the smallto-medium enterprises,” S&P said in its report.
S&P this week revealed China has jumped ahead of the U.S. to become the world’s largest issuer of corporate debt. The ratings agency said it estimates that China’s outstanding corporate debt was US$14.2-trillion at the end of last year, compared with US$13.1-trillion from U.S. firms. That makes China incredibly important to the global financial system.
The Chinese consumer is also growing in importance to investors in American, Japanese and European equities, notes Pierre Lapointe, head of global rate strategy and research at Pavilion Corp.
He points out that multinational companies in these countries have had an increasing share of their profits come from China.
“Over the past decade, more and more revenues [from S&P 500 companies] have come from Europe and Asia,” he said. “However, Asia has registered the highest growth for revenues of S&P 500 companies.”
All told, the headlines might focus on the ongoing conflict in Iraq and the standoff between Russia and Ukraine, but investors might do well to remember that it is China they should be fretting about when it comes to their portfolios.