A slew of reassuring headlines appeared on Tuesday, arguing that China exposure to the dreaded US subprime mortgage market was limited - or at least manageable.
Reuters reports an assistant central bank governor as saying that the country’s commercial banks had set aside adequate provisions for dealing with potential problems from their exposure, after Bank of China, ICBC and China Construction Bank revealed their holdings of US subprime mortgage-backed instruments.
Moody’s also got in on the act. The rating agency revealed that it saw no near-term impact on the ratings of Chinese banks from subprime despite the total of $13.6bn reported by three of the country’s big four state-owned banks.
But it could be that in China investors should be looking closer to home for worrying exposure inside the nation’s lenders and other companies.
Strong earnings growth in China has been used by some to justify the higher valuations there than elsewhere in Asia.
But, reports Jamil Anderlini in Tuesday’s FT, what if it turns out that growth is underpinned by the country’s soaring stock markets, rather than core profits?
Profits rose on average by 71 per cent in the first six months of the year for the more than two-thirds of listed Chinese companies that have already published results. But operational profit growth was only about 35 per cent, according to Jerry Lou, equity strategist at Morgan Stanley.
So up to half of the heralded earnings growth of companies listed in Shanghai and Shenzhen may have originated from piling into the country’s red hot stock market. Almost a third of those companies’ income in the first half was non-operational, up from 13 per cent in 2006, and much higher than most developed markets where non-core income usually accounts for less than 10 per cent of total profits.
And this is the market that sent Bank of China A-shares up 1.3 per cent at the end of last week on the back of news that it had $10bn of subprime exposure. BoC’s Hong Kong-listed H-shares fell about 6 per cent on the same announcement.
Financial companies derived 26 per cent of first-half profits from non-operational income in the first six months of the year, Anderlini adds, up from 8 per cent in 2006.
Subprime be damned - stock market exposure could spell quite some profits slowdown when the easy earnings evaporate.
