Far too many investors make the mistake of believing that just because a certain asset, asset class or even jurisdiction is “hot” or let’s say has had a remarkable track record (as is the case with China), it automatically means that everything you touch will turn to gold right away. Unfortunately for them, such beliefs are inaccurate at best or childish at worst.
In our case, yes, China most definitely puts genuinely remarkable opportunities on the table and if you make wise asset allocation choices with respect to Chinese assets, the likelihood is high that even if your timing is off, you will be happy with your returns in the long run. But again, there’s the timing dimension to be aware of, with “long run” being the operative word. Problems start appearing, however, when people believe that short-term turbulence issues are rare to non-existent and that’s just plain wrong.
The Great Recession of 2007-2008 represents perhaps a textbook example. Those who acquired even the best Chinese assets (or let’s say emerging market assets in general) but did so just before the Great Recession hit experienced tremendous short-term paper losses. If they had the financial stability necessary not to need liquidity and were able to hang on to them, they are most likely fairly happy at this point. Those who were forced to sell, however, ended up seeing their paper losses turn into “real-world” losses.
You need to understand that despite there being few events or circumstances capable of stopping China when it comes to its long-term journey toward economic domination, the path to becoming the world’s #1 economic superpower won’t be smooth, just like it hasn’t been for the United States and previous superpowers. And it’s precisely those short-term hiccups that can prove to be devastating if you are impatient, over-leveraged or variations thereof.
Just how robust is your China-oriented strategy?
This is the #1, #2 and #3 question you need to be constantly asking yourself. A solid strategy when it comes to any jurisdiction and China in particular that revolves around terms such as “hope” or “optimism” is fundamentally flawed. If you are not liquid enough to be able to withstand short to mid-term pain brought about a financial calamity or something along those lines, it’s time to seriously re-think your approach.
As China keeps growing and ultimately becomes a “safe haven” jurisdiction such as the United States, short and mid-term turbulence will become less of an issue (not still anything but non-existent). But at this point, that is hardly the case because markets do not yet consider the Chinese economy mature enough to be perceived as a safe-haven jurisdiction. On the contrary, Chinese assets are what one calls “risk-on” assets or, if you will, assets that perform well when the market is optimistic and rather turbulence-free. Should problems occur, not only will investors not flock to Chinese assets like they do when it comes to US Treasuries, they are likely to do the exact opposite at this point in time.
In other words, should a financial crisis start tomorrow, Chinese assets will be fairly high on the “to liquidate in case of emergency” list of the average investor. While this reality may very well only prove to be temporary, it’s a reality nonetheless. Time and time again, investors who consider one jurisdiction or another some kind of an El Dorado of finance end up being burned. And after that happens, many develop a resentment toward the jurisdiction in question. The end result is that not only do these investors lose money, they also miss out of various future opportunities after losing money due to poor timing.
Should you have exposure to Chinese assets?
Are those who “bet” on China likely to be rewarded in the long run?
While nothing is certain, yes, the probability of doing well in the long run is on the high side when it comes to Chinese assets.
BUT (and therein lies the key to understanding this article’s message) if your strategy is not robust enough to withstand short-term turbulence that can and will occur every now and then… well, it’s time to go back to the drawing board!