Friday 12 June 2009
Investors pouring good money after bad into black hole
In other words, the new loans being made now are good money being poured after bad into a black hole. The growth investors are banking on will be poor quality at best, and the stock valuations that their money is supporting are looking seriously over-extended.
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Investors pouring good money after bad into black hole
Tom Holland
12 June 2009
At yesterday’s close, Hong Kong’s benchmark Hang Seng Index was priced at 17 times expected earnings for this year.
To put that number into perspective, throughout the long bull market that prevailed from April 2003 to October 2007, the index’s average valuation was just 15 times earnings.
In other words, Hong Kong stocks are more expensive now, in the middle of a brutal downturn, than they were during the fat years of the up cycle.
It makes no sense, but it’s not hard to see why.
In an effort to stave off depression, the world’s central banks are pumping out money, and a lot of that money is flowing into Hong Kong.
Investors everywhere seem to have decided that it will be China that leads the world out of this recession, thanks to the mainland government’s determination to spend as much as necessary to maintain its economic growth rate. And for the vast majority of China bulls, the simplest way to implement their view is to buy Hong Kong-listed stocks.
As a result, according to specialist research house EPFR Global, investors have pulled US$23 billion out of safe-haven money market funds so far this year and pushed US$26 billion into emerging-market equity funds. Much of that money has been channelled straight into Hong Kong’s stock market, pushing the Hang Seng Index up 57.5 per cent over the past three months.
Recently, the trade has acquired a momentum all of its own. But whether it makes sense is a different question altogether.
Whatever investors may think, the mainland economy is in big trouble. Export industries, which have powered growth for the past decade, have been caned by the global economic slump. In May, exports were worth US$88.8 billion, down from US$91.9 billion in April and a thumping 26.4 per cent below the value of exports in May last year.
Of course, the mainland authorities have not sat idly by during the downturn. Extremely aware that their mandate to govern is based entirely on their ability to procure economic growth, officials have responded to the slump by commanding the mainland’s banks to ramp up lending in order to support investment growth.
The results have been spectacular. If reports that banks made about 600 billion yuan (HK$680 billion) in new loans last month are correct, then the mainland’s banking system will have splashed out 6.5 trillion yuan in net new loans over the past six months. That’s equal to 20 per cent of last year’s gross domestic product and almost as much in new loans as banks made over the previous two years.
All that lending has certainly kept investment rates high. Fixed-asset investment was up by a hefty 32.9 per cent in May over the same month last year, the fastest growth rate in five years (see the second chart).
When you factor in that China’s producer price index - a rough proxy for the cost of investment goods - was down 7.2 per cent compared with 12 months ago, that equates to a 40 per cent increase in investment in real terms.
That will keep growth rates high in the short term, but it looks like a bad gamble for investors.
Research by the Hong Kong Monetary Authority indicates that each dollar of stimulus spending on the mainland procures just 80 cents worth of output, while the state companies that are the recipients of most of the new lending have only been able to turn profits during the good years because of the generous borrowing terms they have enjoyed.
In other words, the new loans being made now are good money being poured after bad into a black hole. The growth investors are banking on will be poor quality at best, and the stock valuations that their money is supporting are looking seriously over-extended.
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