There are times when you get caught by surprise, there are times when you get dazzled by the headlights but you know something is coming then there are times when you see the smoke signals in the distance and there is plenty of advance warning. Chinese REITS are of the latter ilk. In fact the whole Chinese Stock Market at 37 times earnings seems to represent a giant bubble.

The acronym BRIC (Brazil, Russia, India, China) has been the road to profit for many investment managers but this all looks set to change. The growth in developing markets has attracted speculative money, and lots of it, China would be the most extreme example of this, their largest companies are now ranked in the top ten in the world (by market capitalization), as far as I am currently concerned now is the time to pull out.

Since the beginning of November Hong Kong property stocks have fallen 40% mostly in the area of REIT’s.

[REIT’s: This stands for ‘Real Estate Investment Trust’, this is an investment vehicle that is used for investing in property in the same way that mutual funds invest in the stock market, they typically have tax breaks attached but the general caveat is that 90% of their profits have to be distributed and the tax is paid by the recipients.]

The Chinese Government has been steadily raising rates to avoid a speculative bubble but the money is pouring in from outside as well and that can’t really be controlled, foreign investment is a very large factor. Meanwhile inflation there is at an all time high, 7.3% for the twelve month period to January 2007. So there is a mix of inflation as well as an overheated property and stock market. China’s property slow down is looking quite similar to the one the USA experienced from 2006. What will likely happen is that there is an initial bear run at the fund/investor market level and this will spread down to the the residential level.

So that the current mix, inflation, stronger currency (which will hit export ability as well and thus GDP eventually), a deflating property sector and a market that is poised to go into free-fall.

On the bright side commodities such as pork will perform well due to Chinese demand (there was a blog post on this back in Jan/Feb).

Now onto US Manufacturing, I feel bad for America, George W. has all but ruined the place, putting the Americans into a debt that it may take more than a generation to clear, he did this starting with surplus which he morphed into the biggest deficit in history. Nice work. The Institute for Supply Management have an index and it fell from 50.7 to 48.3 in January, anything below 50 indicates that the market is contracting. This is coupled with a huge decrease in building activity (even for large semi-public builds). In January I had said that we had entered a recession which we would only start to honestly call a recession at the end of quarter one. I think I got it right, that’s always a good feeling for an idiot like me.

Oil also hit a record $103.95 which means the USA will feel an inflationary pinch along with a decreased manufacturing output, thats a classic stagflation environment and one that was brought about by and large by their political regime, I’m almost genuflecting in prayer hoping that Obama gets into office, if another warlord republican gets in we’re all going to feel the economic effects.

Oil worldwide is traded in USD so the movements of that currency (which fell to all time lows very recently) mean that oil gets cheaper for those with strong currency, demand throughout the developing world is quickly rising and now because of the weak dollar these nations can afford to buy the amount they want rather than the amount they (in the past) can budget for. Iran is also talking about moving to a Euro or non-dollar based oil exchange. This would hurt the US economy to no end as all of the for-ex would start to be repatriated, thus far the US can print all the money it wants because it has to be held for worldwide energy transactions, an end to that system would be a stake through the heart for the American economy but to be fair that idea requires a blogpost all on its own.

So what does all of this mean in a greater context? China is the USA’s biggest supplier for consumer goods and the US economy operates on consumer spending, China is heading for a slump and the US is already in one, its a knock on effect in one way but in another it is also a way to level the playing field, a recession in China would be good for the USA as it would be a step towards further liberalisation of the Chinese currency, if they want to weaken their currency in a time of inflation the only way to get anywhere near that is to float it. As well as that the weak dollar will mean that the USA might start to manufacture again as imports become expensive, this would be good for the general economy and perhaps in the long term it will ensure that there are jobs and productivity irrespective of what happens on the worldwide platform, it would be an inroad towards holding the industrial crown which was recently lost to the east. But first things first, let’s get through this recession, it will be bumpy, they always are, the only fear this time is that we don’t really know how far the rabbit hole of sub-prime mortgages goes, only today HSBC announced an €11.3 billion loss.