Beware of China!

The Chinese bubble will keep inflating, and after a short pause, currency peaks will be broken in Shanghai, Hong Kong, and the depreciation of the Chinese currency will begin* –  says the ‘king of shorting’ American investor, portfolio manager and CEO of Eos Funds, Jon R. Carnes.
In the interview he gave to Fundblog he expressed his negative opinion on the authoritarian politics of the Chinese government, which as he believes, gives cover to companies that falsify data. At the same time, his opinion on the American political and economic system is not too flattering either. He tries to prove that governments cause severe damage by ‘robbing’ the little people of their savings and force them to turn towards the capital markets, promoting the creation of price bubbles by doing so.
Jon Carnes also makes money on the American and Chinese stock markets protected by interventions. On the short-term, he expects a correction in America; however, he suggests purchasing the now extremely cheap raw material companies.

Péter Zentai: What do you think of the most recent intervention of the Chinese authority?
Jon R. Carnes:
The market intervention by the state is a part of the essence of the Chinese system. We must prepare for the continuous depreciation of yuan (RMB). This is what I have been suggesting to everyone who is interested in China – in the recent years, yuan has become the most expensive foreign exchange in the world. So a gradual depreciation will be characteristic for the upcoming period. Of course, it will cause troubles to China’s competitors, but they have made huge profit on the overvalued yuan already.

You have been criticising China for years, and revealed many elements to prove: the Chinese market and economy is rather spurious and its essence is the manipulation of the capital market…
Chinese investors know that the majority of listed companies exaggerate their business accomplishments and probably commit financial frauds as well. This is why there is nobody in China who makes long-term investments on the local stock exchange. The Chinese see their stock exchange (in Shanghai) listing local companies as a casino, where they are gamblers rather than investors. They make short-term deals and know that most of the operators will lose.
The Chinese management would like if listed companies served as long-term investments, but people do not have the confidence for that because they know how awful the situation is in corporate governance.

Has it showed any sign of improvement since you published your concerns five years ago?
The level of transparency has not changed at all. Local investors do not even expect any improvement, since Beijing does not care about the quality of corporate governance.
What do you, as a reputable short-seller, think of the Chinese authorities banning this kind of transactions?
Of course, I disagree with such bans. Shorting with no restrictions is the most efficient tool of investors against companies that exaggerate their financial performance or business prospects. Shorting also alleviates liquidity because short-sellers often sell during boom and purchase during fall – in other words, they stand on the side where there are fewer people.

In any case, it somewhat offers comfort to foreign and domestic investors too that Chinese authorities – as we saw it in the recent weeks – make serious purchases on the stock market in order to prevent dramatic price drops.
I oppose any kind of state interventions on the capital market. What the Chinese authorities do will have many, yet unforeseeable consequences. Remember when in the 2000s in America, prices became absolutely unrealistic because investors believed Fed would have intervened in case of a stock exchange crashl. The so-called ‘Greenspan Put’ led to over-speculation, and we can see the same happening in China. When the Chinese bull market starts over, speculators will peak prices since they already know the authorities will support the market in case of a correction.

How long can this unique Chinese political-economic system sustained?
It is difficult to tell how long the totalitarian elite lead China. For me, the nominally communist Chinese political system does not differ very much from any other political system, especially from restricted democracies such as the two-party system of the United States. The ‘government’ still means the monopoly of power which is used to protect the elite against majority. China at least has the advantage of not having illusions regarding their clearly totalitarian political system. The people of the United States or other democracies rarely realize how autocratic their formally democratic system.
The Chinese economy has significantly improved its sustainability by shifting towards the free market. However, it has the disadvantage that interventions by the government will create bubbles in the property, share, and exchange markets, which are terribly overpriced.

Based on that, what do you trade in China?
Even though I expect new peaks in China, it is clear that investing in China is a gamble. This is why I rely on short-term investments, and I cover my long positions with short positions at companies which are likely to be charged with fraud. Taking the culture of corporate governance in China into account, I do not recommend buying Chinese shares to ordinary investors.

You do not deter us from the American and European capital markets, do you?
I do not really keep up with Europe. As for the American shares, I have been ‘bullish’ since 2009, and – though I expect corrections in the long-term – I still purchase them. I secure these positions too by shorting overvalued companies of suspected fraud.

What is your opinion on the asset bubbles resulting from quantitative easing and zero interest-rates?
Inflation naturally rids people of their savings. If a government starts extreme money printing, asset prices skyrocket as a result of the inevitable purchases by the public, since this is their only defence against the devaluation of their savings.

What do you think of exchange and raw material market investments?
Currently, I find the American coal, gold/silver, oil and gas producers with downward pressured prices quite intriguing. These shares crashed and now are coming back to levels where I find them appealing again. I mainly focus on America and China because I know these the best.

Original date of Hungarian publication: August 12, 2015