Perspectives

You Can’t Make This Stuff Up

If someone promises you 80% returns on an investment and only accepts large payments would you run out and borrow money from friends and banks, sign up and max out credit cards and go all in?  I hope not. Many in China did.

In what may be the largest ponzi scheme to date (but not the last) !!!200 million!!! Chinese “investors” may have lost everything and more (loans) to an online financial company.

Caixin learned that many of Qbao’s investors borrowed heavily from banks or online micro-lenders to invest in Qbao with the aim of profiting from the interest rate gap. A 26-year-old investor told Caixin that he had applied for seven credit cards to withdraw money for investments in Qbao. With Qbao’s collapse, he is now defaulting on his bank loans.

“I don’t know what I should do,” he said.

I have called China the land of a million ponzi schemes.  Ponzi schemes thrive in credit bubbles.  With schemes this large you don’t need a million of them to take down a financial system.  Imagine a million Americans getting hit by one scheme.  I guess in China, it wasn’t enough to educate the masses because they had one last year.

Last year, a leading online peer-to-peer lending service Ezubao was accused for swindling over 900,000 investors of more than 50 billion yuan in less than two years, using fake companies posing as borrowers.

I can not help but think that 200 million losing money on a scheme would not have effect on the financial system and people’s behavior.  But China’s government can do what it did after the financial crisis if need be – order state owned banks to lend to state owned companies to build state owned apartments and buildings to generate virtual demand when the credit cycle slows again. And that is how you grow the largest global credit bubble in history.

One wonders how much of the private debt in China is wrapped up in their massive real estate bubble or other get rich quick schemes even if they aren’t quite so bold as to advertise 80% returns.  The Chinese have taken on a lot of debt since the financial crisis and China is the second largest economy in the world.  So China is integral to the global credit bubble and something to continue to watch.

China Debt

While China is the second largest economy in the world, it is still considered an “emerging market” and makes up the bulk of many emerging market funds.  Most large international funds (such as the TSP I fund) do not currently include emerging markets stocks. Over the last year there has been a big push for investors to include emerging markets as part of their portfolio.  They do come with additional risks that need to be monitored.

Too often I read articles or marketing material that provides broiler plate advice about diversification.  It is not as simple as investing equal parts in large cap, small cap and international funds.

I like to remind investors that the SP500 obtains 30% of its revenue from non-US countries and that includes emerging markets.  The fastest growing SP500 sector is the Tech Sector and it obtains 60% of its revenue from non-US sources.  This needs to be considered when allocating to international funds.  There is very little tech in the developed world minus US (MSCI EAFE index or TSP I fund) since most developed world tech companies are listed on the US exchanges.

The SP500 should be the majority of your equity allocations unless you have good reasons otherwise.  And no, small cap funds (TSP S fund) have not outperformed the large SP500 since 2011.

Invest safe, invest smart.


TSP & Vanguard Smart Investor