Last week, I outlined one of the biggest risks facing the financial markets – an economic “hard landing” in China.
Morgan Stanley’s (MS) asset allocation team recently noted, “Our baseline case is that China may slow from the current level of 7.7% gross domestic product (GDP) growth to 5.0% over the next two years.”
They also pointed out, “a disorderly unwind [of credit excesses] could take Chinese growth down to 4% in a shorter time frame with potentially disastrous consequences… One of the more controversial conclusions of our analysis is that global economic growth could be impacted severely enough to cause a global earnings recession.”
Indeed, if the worst-case scenario for China materializes, no portfolio is safe.
Those already in retirement will see their account values decline significantly – and others will have to push back their planned retirement dates.
Global property prices will also be adversely impacted.
Basically, the big risk now is that a situation develops which closely resembles the credit crisis – except with China as the epicenter, instead of the United States.
So what can we do to prepare for this threat?
It’s simple: Avoid stocks that are the most exposed to a disaster in China.
Dangerous Dividend Yield
It takes large quantities of commodities to build vacant office buildings, unoccupied cities and untraveled roads, such as what China has done.
Rising stockpiles of industrial metals, such as copper and iron ore, are sending a warning signal for investors in mining giants BHP Billiton (BHP, BBL) and Rio Tinto (RIO). (I didn’t mention Vale S.A. (VALE), because its dividend cuts make it unsuitable for income investors.)
Since the peaks in many commodity prices in 2011, BHP and RIO have struggled to produce sufficient free cash flow to cover their dividend payments. This means that a hard landing in China would be particularly devastating to these firms, as well as companies that are highly dependent on continued mining capital expenditures, such as Caterpillar (CAT).
Of course, the Australian economy and property market are very closely tied to the prosperity of China, as well. This makes the Australian banks, including Westpac Banking (WBK), especially vulnerable.
Now, some companies that are seemingly removed from the commodity complex – but derive a significant amount of revenue from China – also pose a threat.
Are You Feeling Lucky?
Because of their casinos in Macau, Wynn Resorts (WYNN) and Las Vegas Sands (LVS) rely on the greater-China region for 72% and 64% of their sales, respectively. (MGM Resorts Int’l (MGM) also has exposure, but it doesn’t pay a dividend, so it’s not in our universe of income investments.)
Analysts expect WYNN’s 2016 earnings to be over 50% higher than 2013 levels. Anything that jeopardizes this growth could significantly affect WYNN’s stock, given its 26x forward price-to-earnings ratio.
To top it off, individual stocks aren’t the only investments in the crosshairs of a China credit crisis… There are several exchange-traded funds (ETFs) that risk-averse investors should avoid, too.
These two ETFs have 37% allocations to banks – a significant overweight.
Remember how the U.S. financial sector performed during the credit crisis? Not well.
And as I alluded to above, there’s an ominous similarity between the current situation in China and that of the United States after the subprime mortgage market started to implode in 2007.
Bottom line: There are plenty of high-yielding investments out there. So there’s simply no reason to be overexposed to what could be the next big risk to your retirement.
Safe (and high-yield) investing,
Alan Gula, CFA