Estimates for growth in China keep dropping. While analysts keep saying growth in China this year will be strong, I think it is interesting that there have been multiple downgrades in the last month of the growth target most in the analyst community are looking for.
While few economies were stronger than China over the last several years, the combination of an overbuilt real estate sector and heavy exposure to Europe are taking their toll.
Today, Chinese stocks are trading near multi-year lows. While analysts have talked a good game about growth in China this year, the performance of most Asian markets compared to the major U.S. indexes like the S&P 500 (SPY) has been very poor. Let's look at a 2 year chart:
As we can see, the FXI (FXI) has underperformed the S&P 500 by a fairly wide margin over the last several years.
Still, since many Chinese companies don't yet trade on open exchanges, Chinese ETFs are somewhat limited in giving market observers any true insight on the overall shape of the Chinese economy.
If we look at the holdings of the exchange traded fund FXI, about 30% of the fund holds China Mobile and two Chinese banks. While the fund's underperformance compared to the S&P 500 is notable, the fund is still not heavily exposed to significant parts of the Chinese economy. So, if traders or investors believe that certain parts of the Chinese economy, like the real estate and construction industry, are likely to remain weak, where should they go if they want to take a short position?
I think the best way to short China today is by taking a position in the dollar against the Aussie (FXA). While Australia is not leveraged to all parts of the Chinese economy, I think Australia is the most exposed country to the real estate and construction industry in Asia.
Indeed, while the Aussie has performed well during the recent risk-on rally, the Australian economy still faces some big challenges ahead. First, as I discussed at length in several of my previous articles, the real estate and construction industry in China have been massively overbuilt, and housing prices continue to fall in most major Chinese cities. Regional banks and even some local governments also have significant debt loads from many of these wasteful projects.
Australia is uniquely affected by China's weak construction market because of their geographic location and significant copper and iron ore reserves.
While other commodity-based currencies like the Canadian currency (FXC) are more tied to growth in North America, the Aussie trades much more on Asia's growth prospects. Also, Australia does have some significant oil reserves, unlike Canada, Australia is richer in iron ore and copper. Australia is also far less of an agricultural powerhouse than Canada.
So why hasn't the Aussie sold-off harder up to this point, and why would it sell-off more moving forward? I think despite the market awareness of China's economic challenges over the past couple years, their are several important catalysts that could cause the Aussie to decline against the dollar and other major currencies over the coming months.
First, while China's economy has been known to be weak, economists continue to downgrade their growth outlook for the Chinese and Australian economy. The recent Australian jobs report that I talked about at length in another article, came in nearly 15,000 jobs below expectations. Economists were expecting the economy to experience a modest gain in jobs, when in fact, the numbers showed that jobs were lost.
Also, with the eurozone remaining weak and China's real estate and construction bubble just starting to burst, further economic revisions down in the near-term are likely. Recent earnings reports from major European companies like Siemens (SI) have also been well below even recent analyst expectations, and suggest that the eurozone continues to grow at recessionary levels.
The other reason I think know is a great time to begin to short the Aussie is because of the very weak current condition of the Australian housing market. While the Australian is mostly discussed as a window into Chinese demand for raw materials, Australian homeowners face a very similar dilemma to their American and Asian counterparts. Today Australian housing prices continue to fall, and debt to equity rates amongst Australian households are at an all-time high.
The Aussie has also been in a significant downtrend during the last month, even while the market has rallied:
As we can see, since late February the Aussie has continued to trend lower even while equity markets have rallied. While the Australian housing bubble was not as big as that seen in other countries, the mining boom in China spurred significant overbuilding in the Australian housing market as well. Australian households also increased their debt levels by very significant margins as well.
The reason the Australian housing data is particularly important in my opinion to understanding where the Aussie is likely to go against most major currencies in the near-term, is that this data strongly suggests that the Australian central bank will resist raising interest rates for some time. Australia is also a heavily export-based economy, so enabling their currency to depreciate could provide significant industries to many of their export industries.
With oil, agricultural, and other commodity prices now back near their historical highs, some central banks like the Fed are now hinting at earlier than expected rate raises. The market is also now beginning to price this kind of tightening in as well in the fed funds rates. While the Fed is unlikely to increase rates in the near-term, it is likely that the Fed will be more willing to tighten if the economic data continues to improve and core and other inflationary indicators continue to rise.
With Australia heavily tied to the relatively weak Asian construction markets and the country facing significant real estate and debt problems, the Australian central bank may very well keep interest rates low longer than their other Western counterparts.
To conclude, while the Aussie has held up well during the recent market rally, China's real estate and construction industry remains very weak. Also, while Australia has grown impressively during previous years, debt levels amongst Australian consumers are now at all-time highs, and the Australian housing and real estate sectors remain weak.
While few could imagine the prospect of any of the major central banks even talking about rates raises six months ago, today central banks are increasingly becoming weary of increasing inflationary pressures. While shorting the S&P 500 and high growth companies like Baidu (BIDU) and Apple (AAPL) has been a loser for some time, their still seems to be significant pockets of weakness in the global economy.