The Chinese government will be forced to bailout out its over-levered financial system which has become too dependent on risky ‘credit binges’ to continue its rampant growth.
That is the view of Vontobel’s US equity duo Matthew Benkendorf and Ed Walczak, who focused the bulk of their quarterly round-up for the $1.1 billion Vontobel Fund US Value Equity strategy on China and its impact for US stocks.
Under the banner ‘China’s financial system: putting the global economy at risk’, the New York-based duo said concerns over the rapid increase and ‘growing fragility’ of the Chinese banking system had not received enough coverage from investors.
‘Credit has grown at an unprecedented pace since the government loosened the monetary reins to counter the US financial crisis,’ the duo said. ‘Fitch estimates that banking-sector assets alone have grown US$14 trillion since 2008 through to the end of 2012.’
However, this rise is unsustainable, said Benkendorf and Walczak, with financial firms using increasingly complex and unorthodox methods to retain the rate of growth.
The prominence of so-called ‘shadow banking’, concerns over non-performing loans and increased off-balance sheet moves by financial institutions in China, the pair said, will necessitate government action.
‘[Chinese] banks are constantly setting up new, ever more complex off-balance-sheet loan structures to stay one-step ahead of the regulators. Banks are far less prepared for a crisis than in 2008-09 because their cash cushions are much lower,’ the pair said.
‘At mid-tier and smaller banks, cash cushions are largely non-existent. A government bailout of the financial system would take time to work but we believe it will have to be done sooner or later.’
‘Even with a large “big bang” bailout or several smaller ones, the economy will take a significant hit from the end of the credit binge.’
In order to counter these concerns, Walczak and Euro Stars A-rated manager Benkendorf have sought to limit any exposure to US or globally operating US-listed firms which have dependence on China for their revenue streams.
‘The US used to be the economic engine of the world, but tepid growth and continued over-leveraging signals that the US may not be to fulfil that role again anytime soon. If China, as the current key source of demand growth, weakens we believe many other economies will struggle to grow.’
The Vontobel Fund US Value Equity has returned 52.68% in the three years to the end of March 2013. This compares to its Citywire benchmark, the S&P 500 TR, which rose 43.05% over the same timeframe.