Fisher Investments Editorial Staff
Emerging Markets

Bull in a China Shop

By, 04/20/2010
 

Story Highlights:

  • China's benchmark Shanghai Composite Index fell 4.8% Monday, tied to the government announcing additional steps to tame speculative real estate investments.
  • China's real estate and bank stocks took a hit on the news—yet the new restrictions likely can't torpedo China's housing market or economy.
  • Monday's drop rightly reminds investors Emerging Markets are inherently more volatile than developed markets.
  • Investing in Emerging Markets has its many benefits, but it's important to remember that not all are made equal and won't proceed in lockstep.

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Recent data makes it hard to dispute China's bullish economic prospects, but does its benchmark index's sharp 4.8% drop on Monday suggest fragility? More likely, it's a short-term sentiment-driven swing, but importantly, it also underscores the potential for higher volatility when investing in Emerging Markets (EM). 

Following last week's decision to raise down payment rates on first and second homes and setting minimum mortgage rates on second homes at 110% of the benchmark rate, China's State Council announced additional steps this week to tame speculative real estate investments. The new policies prevent banks from loaning to borrowers who can't produce tax returns or provide proof of social security contributions, restrict banks from loaning to homeowners to buy third homes in cities with "excessive price inflation" (to be determined by local governments), and give local governments authority to temporarily curb an investor's real estate investments within a certain period.  

China's real estate and bank stocks took a hit on the news—stocks are never fans of government meddling. Yet the new restrictions likely can't torpedo China's housing market or economy. China's ongoing urbanization continues to drive demand for new housing—China may have an excess of luxury homes, but it has a shortage of housing in general, especially for lower income and/or first time homebuyers. (In 2009, two-thirds of housing transactions involved mortgages—with new homebuyers making up 82%.) And because many Chinese are living in older homes—in many cases rudimentary spaces provided by employers through a direct housing allocation system (remember, communist)—there's significant demand to upgrade to newer, privately built homes. Plus, the Chinese government announced the building of three million low-income apartments and the renovation of another 2.8 million this year. Even with that, it's likely demand for housing outstrips supply as more Chinese move to urban areas, looking for better-paying jobs in an economy that continues to clip along nicely. That likely continues to prove bullish for Chinese stocks. 

However, Monday's drop rightly reminds investors Emerging Markets are inherently more volatile than developed markets. Their greater growth potential and often rapid growth can induce big near-term returns relative to developed markets. But certain risks in developing countries can be more meaningful than in the developed world. For example, EMs can be subject to a higher degree of government controls (China is an extreme example), leading to increased uncertainty relative to countries with freer markets. EMs also tend to involve more political risk (but not always—some developed markets also do very well in the political risk department). Additionally, these regions' capital markets are typically less developed—with less breadth and depth.  

No bull market is ever a straight shot upward—and that's true for single countries—but globally diversified investors have room to maneuver, even in what can feel like a china shop. Investing in Emerging Markets has its many benefits, but it's important to remember that not all EMs are made equal and won't proceed in lockstep—and if investors want the big upside, they'll have to accept some near-term big downsides too. A good reminder to do country-specific analysis before charging fully forward to chase the EM heat.

 

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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