What Really Goes On In China

Authored by Edward Chancellor and Mike Monnelly of GMO, Feeding the Dragon: Why China's Credit System Looks Vulnerable Prologue For GMO's asset allocation team, valuations are our first protection against losses. We generally believe that cheaper assets are more resilient against bad economic and financial events, and that if we focus on avoiding the overvalued assets, we should not only achieve higher returns over time, but more often than not do less badly when markets encounter difficulty. From a valuation perspective, Chinese equities do not, at first glance, look to be a likely candidate for trouble. The PE ratios are either 12 or 15 times on MSCI China, depending on whether you include financials or not, and the market has underperformed MSCI Emerging by about 10% over the last three years (ending December 31, 2012). Neither of these characteristics screams "bubble." And yet, China...