Big Trouble in Big China and Europe

11/01/2013 11:00 am EST

Focus: STRATEGIES

Jim Jubak

Founder and Editor, JubakPicks.com

Recently, there's been nothing but bad news coming from the big banks and governments of Europe and China, and unfortunately, writes MoneyShow's Jim Jubak, also of Jubak's Picks, even more bad news might be on the way.

Bad bank loans everywhere.

Well, at least everywhere in Europe and China.

If this coincidence doesn't get your attention, what will?

On Wednesday, October 30, China's big state-owned banks reported, as expected, huge increases in bad loans. For example, Industrial and Commercial Bank ((IDCBY) in New York or (HK:1398) in Hong Kong), the world's biggest bank by market capitalization, reported that, in the third quarter, bad loans increased at an annualized 30% rate. At some of the country's big banks-and this is a really worrying development-bad loans rose faster than reserves for bad loans. At the Bank of Communications ((BKFCF) in New York or (HK:3328) in Hong Kong) for example, the non-performing loan ratio climbed to 1.01% from 0.92% at the beginning of 2013, but provisions for bad loans fell 33 percentage points to 217.5%. The Bank of Communications is China's fifth largest bank.

Two days before that, on Monday October 28, accounting firm PricewaterhouseCoopers reported that non-performing loans at European banks had doubled in four years to 1.2 trillion euros and were expected to continue rising in the year ahead. European banks, the accountants estimated, are sitting on 2.4 trillion euros in non-core loans that they will wind down or sell in the remainder of 2013, and into 2014 and 2015. The first eight months of 2013 have seen 46 billion in European loan portfolio moves, more than the entire amount in 2012.

Both the Chinese and European news comes in front of big impending audits.

In coming weeks, the Chinese government is scheduled to announce the results of an audit of local government balance sheets that is expected to show a bad loan problem that's far bigger than that at China's big banks. (And local governments don't have reserves against loan losses at affiliated financial entities like the banks do. The Chinese government would seem to be the ultimate backstop for these bad loans.)

This week, the European Central Bank announced plans for a comprehensive assessment of the health of EuroZone banks, ahead of the central bank's assumption of oversight for the EuroZone's biggest banks. The PricewaterhouseCoopers' report indicates just how potentially fraught this assessment is. The numbers-especially those for stress tests of individual banks-will have to be credibly tough-unlike the last round that was greeted with skeptical, if nervous, laughter-without leading to a major contraction in bank lending that wound sink the EuroZone's still fragile recovery.

In China, the audit comes close to the November meeting of the country's ruling body. That group is already walking a fine line between reforms designed to move the country further toward economic liberalization and a strong conservative backlash that says any reform will weaken the hold of the Communist Party on the economy and the country.

The potential, in both China and the EuroZone, for moves that slow their economies, shouldn't be ignored by investors and traders over the coming weeks.

Full disclosure: I don't own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund, I liquidated all my individual stock holdings and put the money into the fund. The fund may or may not now own positions in any stock mentioned in this post. The fund did not own shares of any stock mentioned in this post as of the end of June. For a full list of the stocks in the fund as of the end of June see the fund's portfolio here.

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