China: The Emerging Markets (Relative) Haven

The S&P China 500 is down 25% since January 26,¹ an ugly and quick plunge that fits the common definition of a bear market. Who in their right mind would use “haven” in the same sentence as “China”?

We will, in context.

Compared to cash in a Zurich vault, no, China is not even close to a haven. But is its equity market a haven compared to that of other nations in the emerging world? We hypothesize yes.

The Fragile Five

The market’s current focus—and maybe the focus next year too—is the so-called “Fragile Five” current account deficit nations: Brazil, Indonesia, India, Turkey and South Africa (the “BIITS”).

In “Getting More Defensive in European Portfolios,” we discussed the effect the Turkish debt crisis may have on neighbors, particularly Europe and its banks. Along with Argentina, Turkey is at the top of the crisis malaise leaderboard, courtesy of a burgeoning hard currency debt load, runaway inflation that far exceeds the state’s 17.9% official number and its deep 6.5% current account deficit gauge of two-way capital flows.²

Is that latter metric—the current account—the primary reason the BIITS currencies have come under pressure? Yes, but there are other factors. For example, South Africa’s expropriation of Afrikaner farms places serious question marks on general property rights in a nation that has a history of state-mandated equity dilution.

Which takes us back to China. Five-year credit default swaps, which gauge the cost of insuring against default by Beijing, pale in comparison to those of other emerging sovereigns, and for good reason. While it costs $401,000 per year to insure $10 million of hard currency 5-year Turkish debt, the price for covering Chinese exposure is just $57,000.

Beijing is no Bern or Oslo, but then again it also isn’t Brasilia, which faces a major question mark on its upcoming election.No one knows what economic policies the leading candidates may try to implement. From a risk-of-not-getting-paid-on-your-bonds perspective, Beijing is one of those in-between countries— not the most stable, but nevertheless a veritable haven in the context of some of these other governments.