China Drives Away Investors on Hard Landing Concern

If there is any single signal that China may be in for a hard economic landing, it is the performance of the local stock markets on the mainland and in Hong Kong. China announced GDP rose 9.1% in the third quarter. That would be a tremendous feat by the standards of any other large country. The news drove the Hang Seng down 4.2%. It is now off over 20% for the year compared to the S&P 500, which is flat.

The mainland’s major index, the Shanghai Composite, has fallen 17% in the past year. Between the two markets are the listings of giants China Mobile (NYSE: CHL), China Petroleum (NYSE: SNP) and China Life Insurance (NYSE: LFC). It is extraordinary that telecom, energy and financial services industry shares should drop so sharply when none has any direct relationship to the others.

The four concerns about China’s financial health persist. The first is that inflation still lurks even though China’s economy has slowed. The sharp increase in food prices has many economists worried that real wages cannot keep up with the cost of living. And China counts on its middle class to consume a large portion of the output of the nation’s impressive manufacturing sector. Inflation will cause discretionary income to fall.

Property values, particularly in the largest cities, are high by historic measures and compared to similar real estate around the world. Any sharp slowdown in China’s GDP will undercut the ability developers to expand and rent these properties. Individual home owners could be left with large numbers of underwater mortgages. Analysts fear a rapid drop in property values similar to those in Japan three decades ago. Japan’s real estate fiasco helped ruin its GDP expansion, and the recovery from that took several years. By some standards, Japan’s economy has never recovered completely from the blow.

The chance of a trade war with the U.S. has increased sharply in the past several weeks. What was unimaginable has become possible. The U.S. Senate has agreed to a bill that would result in sanctions against China because of its currency problems. The Treasury Department recently delayed its biannual analysis of nations that have used their currencies to put the U.S. at a disadvantage with regard to trade balances. The Obama administration hopes quiet negotiations will resolve the yuan valuation issue. The belief that will work continues to dwindle.

And, the most significant concern about a sharp stall of China’s growth is Europe. Austerity and high unemployment have turned the EU economy back toward recession. If the sovereign debt crisis worsens, the recession could be deep and long. The EU economy is still the largest by GDP, about $2 trillion more than the U.S. A drop in demand for China’s exports could put manufacturing in the People’s Republic into a tailspin.

Stocks markets, some experts say, trade based on investor perceptions of what economies and earnings will be six months to a year into the future. China is in great trouble if there is truth to that.

Douglas A. McIntyre