China: Cautiously Optimistic for the Long TermMay 2014
After 30 years of unprecedented growth of 10% per annum from 1980 to 2010, the Chinese economic miracle is slowing, downshifting to projected growth of 7.5% in 2014. What does this mean for the global economy and the emerging markets in particular? Equally important, how will this impact multinational companies in the developed world that have ridden China’s growth wave?
Some consider the country to be at the epicenter of risk and in the same stage that the US was in during 2008, with accelerating debt levels and on the verge of a real estate collapse. Others embrace China’s ongoing trajectory toward a free market system with the pivot from a manufacturing, export-led economy to a more sustainable consumer-driven model. Which outcome is to be believed? China’s economic metrics have always been considered opaque, but the following statistics cannot be ignored:
- China is currently the world’s second largest economy and constitutes approximately 15% of global GDP.
- The United States’ third largest export market after Canada and Mexico is China.
- Over 50 global leading multinational companies, including Coca-Cola, IBM, Procter & Gamble and YUM Brands, derive over 20% of their sales from the emerging markets, and China is a key driver.
- China has over 600 million internet users, the equivalent of twice the population of the US.
A World Transformed: The Great Leap Forward
To gain a better understanding of China’s emergence as a global superpower, a brief look back at recent history is helpful. After the repressive cultural revolution, China opened its doors to Westerners for the first time in 1978 under the progressive leadership of Deng Xiaoping. A visitor to Shanghai at the time would have witnessed a China virtually unchanged from the Communist revolution in 1949. All citizens wore the ubiquitous Mao jacket and bicycles were the major form of transportation. Over 30 years later, the city has undergone an unparalleled transformation. Office buildings designed by world-class architects dominate the skyline and luxury cars wind along the Bund.
Has the newly-affluent China been overbuilt? Is the labor force no longer competitive? Will pollution and environmental hazards restrain economic growth going forward? To answer these questions, both the headwinds and tailwinds facing China must be examined.
- The commodities super-cycle of the last decade, which fueled the emerging markets boom, has run out of steam.
- The Great Recession of 2007-2008 undermined global growth and slowed demand from China’s major export markets, the US and Europe.
- Public and private debt has accelerated to 220% of GDP, with a proliferation of shadow banking/wealth management loans.
- China faces the twin threats of an ageing population and environmental degradation.
- While the risk of capital outflows from emerging markets has intensified as the Federal Reserve begins its “tapering” policy to allow US interest rates to rise, we believe that China is in the best position to weather the storm.
- Substantial foreign exchange reserves and a largely closed capital account should provide a stable environment to execute long run reform.
- What has been described as a “Beijing put” should allow the government to intervene to ensure a maximum level of growth.
- Under Xi Jinping’s leadership, China is embarking on proactive and visible free market reforms.
We Believe in the Long-Term Case for Investing in China
It is evident that China has made a stunning evolution over the last 30 years from a Soviet-style command economy to the beginnings of a free enterprise system. Fiduciary Trust believes in the long-term case for investing in China. Current leadership in China is actively pushing ahead with a wide range of overhauls to support a lighter, greener, and more sustainable service-oriented model. The commodity-driven economies of Africa and Brazil are highly dependent on China, as are the luxury good emporiums of Europe. Silicon Valley start-ups aspire to reach a country where internet usage is double that of the US.
Caution in the Near Term
Nonetheless, China’s stock market has come under pressure as investors weigh the country’s ability to successfully navigate the current challenging transition. In our opinion, some near-term caution is warranted and we expect continued volatility. As such, we believe it is best to gain exposure to China through Western companies, selectively through direct plays, and via a modest allocation to diversified emerging market funds. While arguments can be made as to whether the Chinese market is overvalued or undervalued, no one can argue that China has become a central player on the world’s economic stage.
Senior Portfolio Manager, Managing Director
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