China means Central Country and it has certainly been living up to its name whether as an
economic powerhouse or as host for the Olympics.
"That is pitiful but not wholly surprising"
Although the credit crunch has put the spotlight on the US economy, China has been just as important to the global economy. It was China’s entry into the global trading system that provided us with cheap manufactured goods for so many years. And it is China, with its insatiable demand for raw materials that has been causing commodity prices, notably that of oil, to surge.
In some ways it should be surprising that it took so long for Chinese demand to feed through to commodity prices. China has averaged 9% growth since 1970. So its boom has been continuous. Partly the delayed reaction is because of supply, which until recently was able to keep up with demand. Capacity at mines and wells could always be made more efficient. Now accessible sources are disappearing, exposing a lack of new investment and geopolitical obstacles.
But the main reason is that China’s growth has largely been based on its workers making things for the West rather than, at least until now, for themselves. When production was moved from developed economies to China, there was little impact on final demand.
The extent to which Chinese workers have deferred spending is apparent in the numbers. Private consumption accounts for just 38% of GDP, compared with 56% in India (which on most measures is probably less developed than China) and 71% in the US. Having now built up manufacturing expertise and reached a certain level of wealth, household spending shows China’s citizens have much the same needs and wants as the rest of the world.
What do these changes mean for the world at large? Clearly China’s economic transformation confers more political clout (which is why the staging of the Olympics is both apt and more than usually symbolic). Clearly, too, rising inflation is complicating policy for central bankers who face simultaneous deceleration in economic growth.
But if the world wishes this inflation away, China can’t really be faulted. It was China that not only provided the cheap goods during the Greenspan boom but recycled its surpluses into US Treasuries, thus allowing bond yields and borrowing to stay low (and only unwittingly feeding the mortgage securitisation bubble).
Furthermore, in today’s interconnected world, it is not necessarily Chinese producers who are the only gainers. Yes, there is nascent resource nationalism; the China that is flexing its muscles in Africa or trying to break up BHP’s hostile bid for Rio Tinto. But many of the producers in China are foreign multinationals. VW is poised to sell more cars in China than anywhere else.
As investors, then, today’s baleful headlines – housing crisis, credit crunch, oil shock – obscure a more profound reworking of where the world’s wealth is produced and distributed. And while this shift may be unwelcome to some, the lack of direction that now governs stock markets is in fact good news. It is booms that should make one nervous because the consensus that underpins them always leads to excess and mistakes.
While the policymakers confront those mistakes now, and the arguments flow as to the prescriptions (more curbs on investment banks, more asset price targeting by central banks, etc) and whom to blame, there will always be segments of the world where there will be activity; activity that means growth and opportunity.
So we must identify where this activity is likely to be, even if unsure exactly when or how it’s going to happen. If the costs of shipping things around the world continue to rise, the developed world will become more competitive. If China is to become more consumption-driven, household debt will rise, creating opportunities for credit card and other finance companies.
Having determined who the beneficiaries of this activity are likely to be, one has to be firm on how much to pay. This in many ways is the hard part. Investors habitually overpay for growth. The Chinese stock market has not been nearly as rewarding as the economic growth achieved would suggest. Since the end of 1992, the MSCI China index has actually fallen 38% in US dollar terms.
That is pitiful but not wholly surprising. While investors have perhaps been inclined to buy a story, they have also paid little attention to what they are buying.
One of the many fallacies of the ‘rise of China’ is that its companies are immunised from normal economic forces. While it’s true they may have access to cheap credit and subsidised energy, the effect is only to distort price signals and crowd out the better-run companies. As it is, the current slowdown and unrelenting build-up of inflationary pressures, led by rising wages, is putting margins under pressure. Finding good companies is still an uphill task.
So we continue to prefer Chinese companies listed in Hong Kong, where standards of accounting and transparency are better than those of their mainland counterparts, or direct investment in Hong Kong listed companies. Moreover, our investments are differentiated by their strong balance sheets and responsible management teams.
Until recently stock prices were a deterrent and we stood aside from the excesses last year. But with the bubble having burst, stock markets in both China and Hong Kong are now at levels last seen 12 months ago. Our appetite is therefore starting to be whetted again. The restraining factor is still earnings, which look elevated given a still uncertain outlook, and one reason why volatility is likely to continue.
Never mind. The Olympics could be the perfect distraction.
Published in Aberdeen marketing
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.