By Data Diary
Let’s be clear – the hedge fund community remains net short Australian banks and some of our major resource stocks. So it’s interesting to hear the rationale for the short China trade from one of the better known hedge fund managers (click here to view the CNN interview with Jim Chanos).
It’s an argument that we’ve been thrashing out with colleagues in the investment community.
1) Australia has had a massive terms of trade boost as a result of the Chinese property building boom. This has principally flowed through to the domestic economy through taxes on these commodity exports.
2) The domestic economy has taken these tax receipts (distributed via tax cuts or government handouts) and leveraged them, via low interest rates, into the housing sector.
3) Australian household leverage has pushed to very high levels by most sensible measures. This leaves the economy vulnerable to a terms of trade shock – principally a downturn in Chinese property construction.
4) The transmission mechanisms?
- A wealth effect from lower share market prices – whatever the failings in logic, commodity companies trade in line with movements in spot prices.
- An income effect from declining GDP – if you accept that debt accumulation has peaked, then following the logic that our housing construction sector is built around continued debt driven demand, it is very exposed to stagnation in debt or worse still deleveraging. While housing construction only directly employs 10% of the workforce and comprises 7% of GDP, the multiplier effects through the economy would be significant. This is why governments of all persuasions are so willing to throw taxpayer subsidies towards keeping the sector growing.
- And the most scary – and by no means certain – is that we then enter a house price correction – with the attendant wealth effects that are currently haunting the US.
Australia’s banks not only face the headwinds of regulatory uncertainty but are seen as a leveraged play on the domestic economy. It’s not hard to see the argument for the short side. A sharp slowdown in China, amplified through the financialisation of the commodity sector, will also have a severe impact on the share prices of Australia’s commodity producers. While I’m not a short seller by nature, there are very few reasons to own the major banks or diversified industrial miners in the current market.