‘Mother of all bubbles’ will pop China stocks: GMO

Peter Chiappinelli, portfolio strategist at institutional money manager Grantham Mayo Van Otterloo & Co. is preparing for the worst from the Chinese stock market.

The firm is currently hedging its China exposure to near zero in the emerging-markets sleeves of its mutual funds, he said. The company has also taken a net short position on China in the hedge fund it operates.

The problem Mr. Chiappinelli sees is that there’s going to be no easy way out of the bubble that exists in China’s infrastructure and real estate.

“China is experiencing the mother of all bubbles,” he said today at the Bloomberg Portfolio Manager Mash-up in New York. “We don’t know when it’s going to pop or what’s going to cause it to pop, but there’s very little track record of countries successfully navigating a soft landing out of a bubble,” he said.

Another problem for China: The likely recession in Europe, said Lisa Emsbo-Mattingly, director of research for global asset allocation at Fidelity Investments. Europe is China’s biggest trading partner and a dip in demand on the continent will be keenly felt in the Middle Kingdom.

Diversified emerging-markets funds were the most popular equity funds in 2011, taking in more than $19 billion, despite having an average return of -19%, according to Morningstar Inc.

China-focused funds were far less popular, suffering outflows of $1.2 billion, or 17% of the $7 billion total. The cash was yanked despite an average return of 8.8%.

GMO was co-founded by legendary investor Jeremy Grantham in 1977. It managed approximately $97 billion in assets as of Dec. 31.