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China’s fragile rebound signals it’s time to move into U.S. assets

Workers install scaffolding at a construction site in central Beijing.

REUTERS

Short-term traders will feel free to benefit from the recent spate of positive economic data from China, but for investors with more reasonable three- to five-year time horizons, the time has come to implement a time-tested professional strategy where U.S. dollar assets are concerned: Hold your nose and buy.

The HSBC Flash China Manufacturing PMI survey, compiled by Markit and released Monday, came in at 51.2, the strongest reading in six months and well above economist expectations.

But this seemingly positive news comes at significant cost – another giant pile of debt added to the country's creaky credit system.

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The People's Bank of China recently reported that: "According to preliminary statistics, all-system financing aggregate reached 10.15 trillion yuan [$1.71-billion] in the first six months, up 2.38 trillion yuan year on year."

The policy problem for China persists: Despite the 30-per-cent increase in total debt, China's growth domestic product growth continues to trend lower. The 7.5 per cent year-over-year GDP growth noted for the second quarter was well below the three-year average of 8.7.

In China, more and more lending is resulting in less and less growth.

Canadian investors will be very much in the way of the inevitable collapse in the Chinese credit growth bubble. As I've mentioned previously the S&P/TSX composite index has closely tracked the emerging markets generally and China's loan growth in particular.

Domestic investors should take advantage of recent Chinese economic strength by moving at least some portfolio assets away from the resource-heavy TSX to protect from China's impending slowdown. The big question is where.

On May 1, the case for U.S. dollar assets in Canadian portfolios was clear-cut. S&P 500 performance for the first four months of the year was 16 per cent ahead of the TSX in U.S. dollar terms. The KBW U.S. Bank Index had outperformed the vaunted Canadian bank sector by 18 per cent.

Then the Fed had to go throw a wrench into the works with the tapering Hokey Pokey. The trade weighted U.S. dollar index fell almost 5 per cent and more importantly, a sharp rise in interest rates now threatens a U.S. housing price resurgence and broader economic growth.

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The outlook for U.S. stocks and economy might be more uncertain than it appeared a few short months ago, but the medium-term investment risks in China are far higher. And, the close link between the Canadian equity market and the Chinese economy means that domestic investors that do not diversify into U.S. dollars (or euros, if they are careful and brave) are leaving themselves more exposed to the failing Chinese economic miracle than they should.

For Canadian investors, adding U.S. dollar assets is more an exercise in diversification and prudent risk management than an attempt to shoot the lights out for portfolio performance. Our country has benefited tremendously over the past decade from searing growth levels in Asia but trends, particularly investment trends, don't last forever.

Thankfully, the U.S. equity market is the deepest, most diversified in the world with opportunities for investors across the risk-tolerance spectrum. Conservative investors can look to health care and consumer staples stocks while technology and financial stocks await more growth-oriented market participants.

Now is the time to diversify your portfolio. Despite recent economic strength, China's burgeoning credit problems are already making it yesterday's investment story.

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About the Author
Market Strategist

Scott Barlow is The Globe's in-house market strategist. He is a 20-year veteran of Canadian investment banks, including Merrill Lynch Canada, CIBC Wood Gundy and Macquarie Private Wealth (MPW). He was a highly ranked mutual fund analyst for 10 years and then, most recently, the head of a financial adviser support team at MPW. More

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