China set for hard landing

There will most likely be a return to volatility in financial markets in 2011 with China set to experience a hard landing at some stage, according to Schroders Investment Management.

Inflation is picking up in China and the economic risks should not be underestimated, said Schroders' head of fixed income and multi assets, Simon Doyle.

While it has been dangerous to bet against China and probably will be in the near term, its strength of growth should not be taken for granted because the risk is real, he said.

“If China were to roll over, it would be a very different economic and investment climate and investors need to start thinking now how they factor that into investment portfolios,” he said.

Investors have the opportunity to put some protection into their portfolios now rather than waiting for something to happen, he said.

Schroders is looking for ideas that are inversely correlated with the broader climate, such as owning foreign currency assets on an unhedged basis. Bond options are also worth looking at because in times of volatility there is a flight to quality, Australia sees interest rate cuts and bond markets rally, Doyle added.

Schroders head of Australian equities Martin Conlon said Chinese demand had driven commodity prices to unsustainable levels and at some stage we could see a large correction.

Most economies that go through the aggressive fixed investment type approach that China has had have a hard landing, Conlon said. The Chinese are generally proactive in solving issues in their economy and are acting early. They are clearly trying to slow down their economy and it is surprising how little people are reacting to that, he said.

“They don’t do what most of the developed world does, which is wait for the train smash then pick up the pieces afterwards.”

Schroders chief executive Greg Cooper said that while most of the world seems to think the worst of the crisis is behind us, there are still plenty of imbalances.

“More than likely there will be some other hit in the next 12 months that comes through — there is a greater chance of increasing volatility than increasing stability,” he concluded.