Downgrade of China. What doe that mean?

Two days ago Moody downgraded it’s rating of China for the first time in 30 years.

China’s rating was dropped to A1 from Aa3. Also the outlook went from stable to negative. This means that further problems and downgrades are possible.

Although the downgrade is only one notch, it is a clear message that all is not well with China.

Beijing was quick to dismiss this event but we could not have expected any other response. We need to remind ourselves that the Chinese government failed to foresee the 2008 crash and that this dismissal of this credit downgrade is certainly not a reference worth considering. 

The signs have been there fore a while:

Debt continues to rise whilst growth of the economy is slowing down. 

Bad debt levels are so large that some form of intervention by the government appears inevitable which will de facto lead to a sizeable increase of the Chinese Government debt. 

On that particular point Moody’s has stated: 

“ It expects the governments direct burden to rise gradually towards 40% of GDP by 2018 and closer to 45% by the end of the decade”. 

This is truly concerning and should worry all analysts and investors.  

We had a very clear sign of the problem a few days ago when the yield curve in China inverted as regulators targeted leverage risk.

Mood’s downgrade is therefore cautious and justified and it is rather surprising that other credit agencies are not fallowing their example.

But what does this mean for China and how can this impact your business?

For investors this is a real sign that today, the environment for global investors is as dangerous and as scary an environment as it has ever been. 

This is becoming “Nightmare on Investor street”.

A portfolio diversification is therefore a sensible and logical step to take.

For Chinese companies this signifies that the cost of money will increase and the issuance of bonds for Chinese corporations and banks will become more costly.

The repercussions will be far greater than most people understand: 

China and Chinese companies are the largest investors in several parts of the world. China also provides significant amounts to aid Africa’s development. In December 2015 China committed US$60 billion to Africa for the following three years. This commitment has been confirmed several times since. 

Although this help is not always as welcome as it should be, due to some unethical practices by Chinese companies in the host nations, Africa needs this funding for its on-going growth and development. 

The repercussions of the problems in China will therefore not only impact their own economy. This will have a much larger effect on the global economy as a whole and various emerging markets strongly linked to China.

If we translate this information into practical applications and give an explanation of possible repercussions, this signifies that for companies on the ground working with or competing against Chinese firms in Africa and other parts of the world, the following scenarios are likely when dealing with Chinese companies:

The default risk by Chinese companies has just become greater!

If Chinese companies are either supplying equipment or are meant to pay a company, business managers need to reconsider their terms and conditions to protect their business and projects.

It is also worth considering alternative suppliers in case of a default.

Up to now the Chinese offer was often the cheapest. Today this cheapest solution might not necessarily be the best for a project.

Today is a case and point of the old saying that “cheapest is not always best”

On the other hand for companies competing with and against Chinese firms, this news might be welcome. This should make them more attractive when bidding for projects and a new sales push is worth considering to capitalise on the Chinese wows.

As usual with any problem in the financial and economic sector, this situation will be catastrophic for some and provide opportunities for others. 

For investors the situation is rather different:

There is not much good news from what has just happened. 

The investor environment is now a danger zone 

Recognising this new climate is of paramount importance if major losses are to be avoided in a portfolio.

Although there is no need to panic and pull the rip cord to jump out of the investor plane flying on a route towards oblivion, proper analysis, cautious diversification and savvy re-investment is now required.

It will mean

? Looking at safer but lower yielding assets   

? Going back to fundamentals

I have always been of the opinion that in situations of instability, precious metals in general and physical gold in particular should be part of your portfolio. 

My last two articles described the problem that we face in Europe

? Trouble for Europe 

? Once the dust has settled, gold will shine

We must now add a new destabilizing factor: China

I predicted that 2018 was going to be a difficult and volatile year. The markets have not let me down. 

We can now add another ingredient to the volatility cocktail that this year is serving up and this rollercoaster ride is only going to get worse.

 Conclusion

One point was obvious weeks ago but is now blaringly staring at all investors today: You certainly do not want all your eggs in one basket. 

If you insist on having them all together, make sure that you have different ones and that one of them is a physical golden egg. 

That physical golden egg could truly make a difference to your portfolio.

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