For well over a decade, China has been an engine of global economic growth. Yet that growth is slowing down. While the Chinese economy once regularly saw growth above 10%, it is now officially stuck at around 6%. Some believe that the real number is even lower—George Soros thinks its 3.5%. Because of China’s importance to the world economy, fears of a mere slowdown—let alone a hard landing—have spooked the markets.
Over the past two years, the once tightly controlled Renminbi (RMB) has weakened around 10% against the Dollar—and many think a further devaluation is inevitable. The free market RMB rate in Hong Kong is weaker than the Mainland fixed rate, suggesting the market thinks the Yuan will continue to slide.
The Shanghai Composite Index is currently down around 18% from its 2015 closing price. Last year was also a difficult time for markets in China, and the government was forced to step into the market to prop up prices. Many believe these actions are only postponing future setbacks in the Chinese market. Despite these headwinds, China is officially still growing at over 6%, a rate that is the envy of the developed world.
If this rate turns negative, expect big problems. Given the still weak global recovery from the Financial Crisis, a full-blown Chinese recession would be even worse—probably dragging down the entire world with it. Let’s look at the best ways to protect yourself, and profit, should a slowdown occur.
Short Chinese Stocks
In most crises, shorting stocks is one of the best ways to profit off a decline in the markets. However, due to restrictive regulations, it is difficult for foreigners to short Chinese stocks. Yet there are a few ways around this issue. One of the best is to invest in short Exchange Traded Funds (ETFs). These ETFs grow in value if Chinese stocks decline. Some of them are levered, meaning that any moves—either positive or negative—are doubled or tripled.
The Direxion Daily CSI 300 China A Share Bear 1X Shares (CHAD) stands out as a good option. Regulatory limits mean there are very few ways for average foreign investors to short Chinese A shares. Thus, CHAD is one of the only simple ways to short Chinese A shares listed in the Mainland.
Alternatively, the ProShares Short FTSE China 50 (YXI) allows you to short Chinese stocks listed in Hong Kong. Some believe that shorting Chinese stocks in Hong Kong is slightly less effective than directly shorting stocks in the mainland, as the Hong Kong stocks are often somewhat more international and may offer a less pure exposure to the Mainland economy. Still, YXI is a good choice.
Those investors who want to make a big bet on a decline in China should look to the Direxion Daily FTSE China Bear 3x (YANG). YANG is a triple-levered way to bet on the decline of the FTSE China 50 Index. Investors should be cognizant of the risks involved, however. The triple leverage offered by this fund means that for every swing in value in the FTSE China 50 Index is tripled. This is a great way to multiply profits, but is dangerous if things don’t go your way. For example the CSI 300 recently rose 2% in one day—during the midst of a general market decline.
While U.S. treasuries currently yield between a mere .17% and 2.83%, this is far in excess of the negative yields found in Germany or Denmark. While some are worried about runaway inflation, a Chinese recession is more likely to contribute to deflationary pressure. Moreover, this is a highly liquid market which allows you near instant access to your cash. Thus, it offers a high degree of protection and a small but safe profit.
Understand the Big Picture
A true Chinese recession, or even a slowdown, will have wide ranging consequences. Oil could fall further, leading to problems in oil-rich countries like Russia, Venezuela, Saudi Arabia, and other oil exporting countries. While the exact effects of a slowdown cannot be predicted, it is likely that countries like Australia that export raw materials to China will be hit hard.
We can also expect a variety of Western companies to be affected. Brands like LVMH and Apple have seen much of their growth come from China, as have big U.S., European, and Japanese automakers. This means selectively shorting or avoiding Western stocks with exposure to China, or the currencies of commodity driven export economies, is necessary both for protection and profit.
Look to Safe Haven Assets
With great uncertainty in global markets, many believe putting a large portion of your wealth in safe haven assets is prudent in the short term.
Assets like Gold, U.S. Treasuries, Swiss Francs, Japanese Yen, and even Bitcoin can help protect you when markets are in turmoil. Investors in small, trade-dependent economies may even want to convert some of their savings to U.S. Dollars, while those in Europe who are uncertain about the Euro’s future may consider doing the same.
Preserve Cash to Profit on the Upswing
American politician Rahm Emmanuel famously said, “Never waste a good crisis.” Investors should think the same way when considering how to trade in volatile times. Keeping a portion of assets in liquid assets like cash, buys the option to scoop up great deals in the future. Given today’s low inflation, this is a cheap way of keeping your options open.
Stay Calm, Stay Focused
It is impossible to predict exactly what the markets will do—but preparing yourself for a slowdown in China is a prudent way to protect your portfolio for these coming years. The right investments may even earn quite a nice profit—even if markets fall. Take the right precautions now to make sure you’re prepared.