International | Jul 30 2015
By Greg Peel
China’s stock market bubble and bust has sparked ripples of fear through global financial markets this past month, but realistically the world has been worrying about China from soon after the GFC. Prior to the GFC, and the huge stimulus package Beijing was forced to implement before the body of Lehman Bros was even cold, the catch phrase markets associated with China was “stronger for longer”.
China would reshape the global economy, it was assumed, as a trend of urbanisation and industrialisation transformed one of the two most populous countries on the planet into an economic powerhouse. But then we started worrying about a property bubble in China. Then concern turned to the country’s rapidly building debt levels. For a couple of years now the worry has been China’s slowing pace of growth. And most recently, The Chinese stock market’s wild gyrations have generated much angst.
All this time, nevertheless, the much touted “hard landing” expected by many for China’s economy has not eventuated. But the global growth thematic for the next decade or more has always been predicated on China’s ongoing progression from emerging to developed economy. As China’s pace of growth continues to slow, and events like the stock market crash and government intervention appear to set the emergence story back some years, the real concern is that the “stronger for longer” theme so dominant in the mid-noughties may have been a misjudgement.
Not so, says investment advisor AllianceBernstein.
China’s growth continues to slow and the government faces immense challenges in implementing its reform program, acknowledge AB’s analysts, thus there can be little doubt China does pose a short term risk for investors. But just as it would be naïve to ignore that downside risk, it would be equally remiss to focus only on the negatives while ignoring the positives.
They include “China’s extraordinary capacity to marshal its social and economic resources in the pursuit of its policy objectives – and attribute which, since 1978, has enabled the country to lift more than 500 million people out of poverty”.
AB’s recent white paper, Future Shock: How China’s Reforms Are Creating Disruptive Risks (And Opportunities), suggests six globally disruptive changes are likely to result from China’s reform program if it proceeds to plan.
China recently failed to have the renminbi included as an IMF Special Drawing Rights currency, alongside the world’s dominant trading currencies of the US dollar, euro, yen and pound, but was basically told to try again next time. AB believes the renminbi will ultimately become almost important as the greenback as a global trade settlement currency, and equivalent to the Swiss franc as a reserve currency for Asian banks.
Many a sensational headline has been published regarding the Chinese economy’s slide from earlier double-digit growth down to today’s 7%, with the trend still apparently to the downside. But no economy can continue to grow at a double-digit pace ad infinitum. China’s slowing rate of growth reflects a maturing economy and a diminishing risk of the return to the economic bubble-and-busts experienced in the nineties. AB believes growth of 5-6% per year will become “normal” for China, and rather than being deterred, international investors will be drawn to an economy exhibiting greater stability and diversity.
Prior to the recent stock market correction and subsequent government intervention, China was close to being included in global equity indices such as those published by MSCI and FTSE, for example. While July may have been a set-back, AB notes investors will need to make big changes when inclusion does eventuate. China’s share of emerging market indices will increase from around 20% to 30%.
There will be an initial rush of mandated investment in the Chinese market before the volatility subsides and stock selection becomes more important. AB suggests early players will do well from focusing on sector plays such as consumer cyclicals and staples, healthcare and financial services.
Right now the label “Made in China” evokes assumptions of low quality, inferior knock-offs. Those old enough will nevertheless no doubt remember when the label “Made in Japan” was similarly derided back in the sixties and seventies. Today, “Made in Japan” implies an assurance of quality. AB believes China’s manufacturers will soon innovate and move up the value chain such that “Made in China” will eventually carry the same gravitas. Chinese consumers will set trends those in the West – particularly the young – will want to follow.
China’s push to exercise “soft power” on the global stage through institutions such as the Asian Infrastructure Investment Bank will lead to geopolitical realignments, particularly in Eurasia and Eastern Europe, AB believes, and to new investment opportunities in those regions.
In conclusion, AB suggests investors should stop losing sleep over China’s perceived negative risk and start focusing on the positive possibilities. Given the pace of China’s reforms to date, which have outrun most expectations and surprised even the AB analysts themselves on occasion, AB believes China has a better than even chance of turning its aspirations into reality.
The reform process is likely to take another decade or more, and AB does warn that these disruptive changes will need to take place in the next two to three years for investors to be confident that China is indeed on track to complete the reform process.
What is a “disruptive change” exactly? Well think of the brief periods of market volatility Beijing evoked when it clamped down on pollution (shutting down inefficient and dirty processing plants, for example), then on Communist party members’ corrupt indulgences (hitting sales of luxury good imports, including high-end vehicles, for example) and then on shadow banking (flowing through to sharp falls in base metal prices, for example). Each of these reforms caused short term disruption.
But the end result is intended to be a Chinese economy more in line with developed economies, and thus a safer and more robust economy in which to invest.
“We believe that the best way for investors to position themselves ahead of such an event,” says AB, “is to devote more effort to researching the risks and opportunities that China represents”.
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