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Strong China trade growth can’t mask ‘trifecta’ of problems: Saut

Pras Subramanian

There’s finally some good news for China. On a day where the Beijing held talks with Taiwan for the first time since 1949, China reported January’s import growth hit a six-month high. Exports also grew, but data like this usually comes with the caveat that many believe figures from China tend to be inflated.

What isn’t inflated is growing concern that the world’s second largest economy is sputtering. A concerned Jeff Saut of Raymond James points to a trifecta of problems that have hit China (FXI) recently.

In the attached video, Saut notes the first leg of the trifecta was China’s PMI index coming in at less than “50” last week, missing estimates. A reading less than 50 means manufacturing, and thus economic growth, was contracting.

The second leg of the trifecta is something Saut’s calling China’s “Lehman moment,” where the mere rumor that the government would let WMPs, or Wealth Management Products default, sent fear into the markets.

According to Saut, the WMPs are higher yielding alternatives to bank deposits that aren’t guaranteed; these WMP products went from a couple hundred a few year back to more than 200,000 now. Chinese investors apparently believed the failing WMPs would be backstopped by the government or the government-run banks. If China allows the WMPs to fail without a guarantee, Saut presumes there could a huge exodus by investors, thus crushing the massive WMP market.

Lastly, the unwinding of the “yen carry” trade is the third leg of the trifecta. As a refresher, the “risk-on” yen carry trade here involved currency traders and hedge funds borrowing in yen (at low rates), converting the yen into emerging market currencies (like the Turkish Lira), then buying bonds of other emerging markets using leverage. As these foreign bond markets collapsed due rising rates, currencies were hit, and these traders had to “unwind” these bets to pay back original the yen-deminated loans, at a steep loss. These “risk off” trades accelerated recently, and China was pulled into the fold.

The big question here is whether China’s issues mean investors should stay away from emerging markets (EEM). Saut is cautious given the three issues noted above, but he sees opportunity in EM (assuming you have no exposure now). Saut recommends investing in “tranches” here, by using a quarter of your principal in the next month, then investing the next three tranches over the coming year.

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