This nation has a BIG economy yet its largest companies are selling assets. Here’s why! [Wednesday: The Independent Investor]
Miles Everson’s Business Builder Daily speaks to the heart of what great marketers, business leaders, and other professionals need to succeed in advertising, communications, managing their investments, career strategy, and more.
A Note from Miles Everson:
We’re thrilled to share with you another investing insight in today’s “The Independent Investor.”
Every Wednesday, we publish articles about investing because we believe we can achieve true financial freedom through wealth creation.
In this article, we’ll talk about an economic giant and why you should hold off from buying stock in its market.
Continue reading below to know more about today’s topic.
The Independent Investor
Nowadays, there’s nothing to be thrilled about in China’s economy and stock market.
The world’s second-largest economy missed growth estimates last quarter with its gross domestic product (GDP) landing at 6.3%, much lower than the expected 7.3%.
On top of that, China’s once booming real estate market is experiencing a massive downturn. Investments in property development, a major growth driver for the economy, fell significantly in the first half of the year.
To make matters worse, youth unemployment in China hit a record high 21.3% in June. The country’s foreign direct investment and exports are down as well.
That’s not all.
Last June, Swire Pacific and New World Development, two of China’s leading companies, announced that they were selling a combined USD 8.4 billion in assets to raise capital.
The reason for this?
Companies need to fund their operations to meet organizational objectives. To do this, they need capital. However, the Chinese firms mentioned above are operating in a turbulent economy where it’s also tough to borrow money.
As a result, the only way these companies can get capital is by trying to sell their assets.
This is what’s called forced asset sales where a company must sell off its assets to meet liquidity needs or to reduce debts.
These sales are “forced” in the sense that a company wouldn’t sell its own assets under normal conditions.
The presence of forced asset sales in the Chinese market is a troubling sign of what’s to come.
According to Professor Joel Litman, Chairman and CEO of Valens Research and Chief Investment Officer of Altimetry Financial Research, a credit disaster is looming in China.
Defaults in China are on the rise, with corporate debt reaching USD 29 trillion at the end of 2022.
One of the best ways to measure corporate credit risk is by looking at credit default swaps (CDS). This type of financial instrument enables investors or institutions to offset their credit risk with another individual or entity.
Simply said, a CDS provides insurance against the risk of a default by a particular firm or country.
Unfortunately, only a few Chinese firms actually have CDS because there’s not a lot of demand to insure against defaults in the market they’re operating in.
Taking this into account, Professor Litman and his team at Altimetry created a way to measure a company’s default risk. They call this “intrinsic CDS” or “iCDS” for short.
The iCDS is a tool that enables investors to understand a firm’s risk factors and its cost to borrow. Through this metric, an individual will know whether or not to invest in a company.
An iCDS above 500 basis points means that a firm carries a good amount of credit risk.
In July 2021, of the 5,450 Chinese firms in the Altimetry database, only 580 had an iCDS that was at or above 500 basis points. That means only 10% of the companies had a high credit risk.
At present, though, there has been a significant shift. Altimetry has roughly 5,500 Chinese firms in its database and approximately 1,400 of them have an iCDS above 500.
This means that the number of Chinese companies with high credit risk has more than doubled in just 2 years.
As borrowing becomes more difficult, it becomes more expensive for firms to service their debt. This is especially true for companies in China. With higher iCDS across the board, Chinese firms face the risk of a default.
While selling assets may enable these companies to avoid the risk of defaults, they’re shrinking their businesses by doing so… and this only makes them weaker in the long run.
As these firms get weaker, lenders may become more conservative, leading to even tighter credit conditions.
The bottom line?
Investors should hold off from buying Chinese stocks until the credit storm in China comes to an end.
With an uncertain economic and corporate environment, investing in Chinese stocks is a risky proposition for investors who want to protect and grow their investment portfolios.
Keep this insight in mind the next time you survey the global market for opportunities!
(This article is from The Business Builder Daily, a newsletter by The I Institute in collaboration with MBO Partners.)
About The Dynamic Marketing Communiqué’s
“Wednesdays: The Independent Investor”
To best understand a firm, it makes sense to know its underlying earning power.
In two of the greatest books ever written on investing, the “Intelligent Investor” by Benjamin Graham and “Security Analysis” by David Dodd and Benjamin Graham (yes, Graham authored both of these books), the term “earning power” is mentioned hundreds of times.
Despite that, it’s surprising how earning power is mentioned seldomly in literature on business strategy. If the goal of a business is wealth creation, then the performance metrics must include the earning power concept.
Every Wednesday, we’ll publish investing tips and insights in accordance with the practices of some of the world’s greatest investors.
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Hope you’ve found this week’s insights interesting and helpful.
Stay tuned for next Wednesday’s “The Independent Investor!”
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