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If Chinese Real Estate Is A Bubble, What Happens When It Pops?

|Includes:Alcoa, Inc. (AA), CAT, HD, HMC, IBM, INTC, KO, LUV, T, TRV, UUP, WMT, XOM

The Chinese real estate market has rebounded sharply since the financial crisis, and talk of a bubble now abounds. The Chinese government has taken notice, and has undertaken small steps to slow the growth in real estate prices without causing a crash.

It's possible that the Chinese government can curb price growth and bring the bubble under control, but the historical record is full of far more bubbles bursting than bubbles quietly deflating. If the bubble does indeed pop, it could result in a rapid drop in Chinese economic growth. The worst case scenario would see China enter an actual recession, something unheard of in recent decades. What would the impacts of even a more modest slowdown be on the markets?

Commodities and basic materials would bear the brunt of the impact, as slow growth reduces China's demand for oil, coal, agricultural products, and construction materials. But the ripple effects would reach a broad range of industries, including even shipping companies, REITs worldwide, and even wireless handset providers. It's important to note that undervalued yuan helps understate the influence of the Chinese economy, which could surpass the US in size this decade. A Chinese crash and recession would have far-reaching impacts.

HiddenLevers analyzed a portfolio of the following Dow component stocks to see the impact of a China real estate crash: AA, CAT, HD, IBM, INTC, T, TRV, XOM. On aggregate, the portfolio dropped by roughly 24% in value, more than the S&P might drop in the same scenario.

HiddenLevers then rebalanced the portfolio to include companies with a positive correlation to the dollar and other factors which might benefit during this scenario. A portfolio of HMC, IBM, LUV, KO, T, TRV, UUP, and WMT holds its value (up 2%) during the same scenario, while still containing 5 Dow components and major stocks. This shows that while a China crash could have a major impact on your portfolio - it doesn't have to. By holding positions that stand to benefit from a rise in the dollar and fall in commodities, much of the risk can be mitigated.



Disclosure: No positions
Stocks: AA, CAT, HD, IBM, INTC, T, TRV, XOM, HMC, LUV, KO, UUP, WMT