A bond trader's investment ideas for people who think China is stuffed

Photo: Kevin Frayer / Getty Images

For some time market participants have wondered quietly about the robustness of the officially stated Chinese growth figures of 7%.

But since the Shanghai stock market bubble burst, it seems evidence that the economy is in a much weaker state of growth has grown. The Markit manufacturing PMI continues to look bleak and the recent trade data showed a surprise contraction in exports. Both data suggest much weaker growth and, combined with last week’s devaluation of the RMB, also suggest that the economy is slowing faster than even the Chinese authorities are able to stomach.

There are also plenty who believe that China is at risk of an even sharper deterioration in its economic fundamentals.

That, according to Justin McCarthy and Craig Swanger from FIIG Securities, has increased client questions about “China and what a downturn or ‘hard landing’ would mean for the Australian and world economies.”

“Australia is the most China-dependent country in the world. Exports to China now make up 6% of Australia’s total GDP and a whopping 32.5% of total exports. This is up from just over 8% ten years earlier, with the increased reliance on China coming at the expense of exports to USA, New Zealand and the United Kingdom,” McCarthy and Swanger say.

As a result they have outlined what they think is an approach to asset allocation and a bond portfolio that investors might construct if the bearish China scenario, and a hard landing, plays out.

Such a portfolio would include reduced exposure to the Aussie dollar, along with a lower weighting on exporters and outright reduction in stocks, in favour of bonds, in any portfolio McCarthy and Swanger said. They also believe the globe would end up with deflation so long bonds are favoured.

The bond portfolio they have constructed to achieve their goals includes a host of well known corporate names such as QBE, Telstra, Sydney Airport and Australian National University. These and the other names in the portfolio would necessarily be adjusted to reflect the credit risk appetite of the investor. Likewise with the portfolio including bonds issued in Pounds and US dollars tailoring for risk is a must.

But with most of the companies in the insurance, banking, telco and infrastructure space,s it looks a portfolio for any season.

Of course the authors don’t say that a China hard landing will happen. But it’s always good to have options when investing.

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