Tags: Chanos | China | stocks | macro

Beware the China Macro Tourists

Thursday, 25 Jul 2013 08:07 AM

By Jacob Wolinsky

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Sometime in late 2009, a famous short seller made comments that rippled around the globe. Jim Chanos, famous for his bets against companies like Enron, said that China was going through a massive credit bubble that would end badly.

At the time, most people thought Chanos sounded crazy. He was attacked for many for never visiting China, for being ignorant or for making outlandish claims. However, over time, Chanos' predictions have proved prophetic. While Chanos was the outlier many years ago, unarguably today China bulls are hard to find.

Investors can learn a lesson here that sometimes thinking against the conventional wisdom is not a bad idea, but there is something more important to keep in mind now.

As sentiment has turned against China, people who know little to nothing about the country (unlike Chanos, who actually had a good grasp of the underlying economy) are recommending investment ideas that will profit if China's economy slows further. Investors should be very wary of listening to these recommendations for several reasons.

Pundits were screaming to buy Chinese stocks in 2007, 2008 and 2009, as the economy would surpass America's as the largest in the world. However, despite Chinese growth, stocks have had poor performance. The iShares China exchange-traded fund is down 25 percent over the past 60 months versus a 30 percent return for the Dow Jones Industrial Average. Many of these pundits who recommended China several years ago are now saying to short it. Why listen to people who are constantly wrong?

The Chinese economy is so complex that it is likely Chinese leaders are confused as to the picture in many local provinces. Markets are largely efficient, which means most, if not all, the data known about China are already discounted by the market. Assuming one knows all that data, they are "equal to the market," however, few do, so they start at a big disadvantage.

Few got in as early as Chanos, but the smart money started shorting Chinese companies a long time ago. Most hedge funds will not reveal big positions until many months or over a year after taking them. And many funds are starting to disclose short positions in China.

However, they likely already made the bulk of their money. Most people getting in now after stocks are down so much are typically known as the "dumb money."

This brings me to the last point. As Chinese stocks have fallen, valuations have gotten much cheaper. Chinese stocks trade at half the price of U.S. stocks based on price-earnings ratio. It is fair to say U.S. stocks should trade at a higher rate than Chinese stocks do, but double? That seems a bit rich. If one thinks valuations will get lower they might want to short, but that is a bold assumption.

"Macro tourist" is a phrase that was coined by former policymaker turned hedge fund manager Mark Dow to describe investors who left their natural investing area to talk about macroeconomics. Many intelligent investors, pundits, economists, etc. are doing exactly this with China and, in the process, becoming Chinese macro tourists. While this is not to say that one should go long China, it could be more dangerous to go short.

If someone wants to listen to a "macro resident" then they would heed the words of Chanos, who says he would never be short China over the long term.

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