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China's Slowdown Hammers the Hang Seng

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Big trouble has taken over the big economies this week. American markets fizzled on the back of fears over the end of quantitative easing, but a far more drastic uncertainty is locking down China's markets. Hong Kong's Hang Seng (UNKNOWN: ^HSI  ) shed 4% this week after downbeat factory data and a serious cash crunch have cast doubts about any economic rebound for China's slowing economy. While some predicted China's recent slowdown of sub-8% annual economic growth would be a passing slump, it's looking more and more likely that the China we used to know is history.

How will this impact investors and stocks? Let's check what's dragging down the world's second-largest economy.

Interest rates on the rise in China's big crunch
The U.S. and Japan have thrown stimulus at their economies to solve problems, but Beijing's not operating under the same plan. China's government has pushed for reform in its financial sector, a smart long-term move to punish bad lenders and firm up the strongest institutions in the long run. On the other hand, it's crippling in the here and now. Lending rates are skyrocketing, and companies are finding funds harder to come by. That's not going to dig China out of its economic slowdown fast, and the IMF's earlier 7.7% economic growth projection for 2013 may end up being too optimistic.

Short-term interest rates fell slightly on Friday as lending picked back up, indicating that this isn't China's version of the 2008 crisis. While China's government probably won't intervene significantly, Beijing may increase its targets for the money supply in the long run, allowing more cash to filter into the economy. However, with cash inflows slowing down, Chinese investment is running dry.

China is seeing another problem crop up throughout this, however -- one that could threaten its economic growth even more. The country's urban growth has driven prices in cities to unsustainable levels, while many Chinese citizens entering the cities from rural areas aren't wealthy patrons, but poor or middle-class who can't afford such properties. China's housing bubble may be set to explode if the government doesn't come up with a fix.

Manufacturing's also fallen squarely into contraction territory and, as demand wanes in the sector, materials stocks dependent on China for growth will become more dangerous for investors. Chinese materials stocks are in an especially tight spot: the Aluminum Corporation of China (NYSE: ACH  ) , also known as Chinalco, saw its shares plummet 9% this week alone, part of a 38% fall year to date as the aluminum market has declined. Chinalco will have a tough time ahead with cash drying up, lending cutting back, and manufacturing demand mired in contraction. Oversupply has also cut into this company's prospects, as high production of aluminum in earlier years is coming back to bite China now. It's hitting hard across Chinese materials stocks wherever oversupply is concerned, especially at giants such as Wuhan Iron and Steel, the fastest growing of China's leading steel firms that dwarf U.S. competitors.

That problem goes beyond just Chinese-based stocks, however. Firms in the industry, like Alcoa (NYSE: AA  ) , won't be able to use China as a major source of future growth anymore with the manufacturing industry falling. China's slump is another hit to Alcoa's prospects. Moody's already downgraded the firm's bond rating to junk status and, unless Alcoa can pivot away from China to some new source of growth, this stock's prospects look grim. The same goes for the likes of U.S. Steel (NYSE: X  ) , which saw its own credit rating downgraded by S&P on Monday due to oversupply and poor market conditions in the steel industry. As long as Chinese giants like Wuhan continue pumping out steel into a supersaturated market, U.S Steel and its American and European competitors won't be able to recover from depressed prices, and a lack of demand -- something that will grow even worse as Chinese manufacturing demand falls.

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