Real World to Markets: China is Still Rising
Can China pull off the grand pivot it is undertaking from a poor country driven by low-cost manufacturing to a middle-income nation relying much more on services and consumption?
I can feel the savvy consumer of financial news wearing a condescending smirk already. That was the old miracle China everyone naively believed in two long years ago. Today’s media cycle is thick with tales from the country’s rancid underbelly: banks with cooked books, cities choking on smog, and real estate bubbles set to burst. From overlord of the 21st century, China has now become Exhibit A for an emerging markets meltdown, and a new round of smug assurance that the US is No. 1 after all. The popular SPDR S&P China ETF (NYSEARCA:GXC) has lost more than 6% of its value this year, while the S&P 500 (INDEXSP:.INX) back home has gained 12%.
But financial markets are like fevered adolescents who swing from breathless infatuation (everything about her is perfect!) to bleakest disillusionment (what did I ever see in her?). It is sometimes worth stepping back and looking to more mature investors who will be wedded to their current decisions for years to come -- that is, to corporations and other direct investors who are sinking in money that they cannot retrieve with a click on their trading screen.
The verdict among this group is clear: China is back, and in fact, it never really went anywhere. Foreign direct investment (FDI) into the country reached $253 billion last year, according to the Organization for Economic Cooperation and Development. That is the highest total since 2007, and 45% higher than China’s nearest global rival for FDI, which would be the US. It is 10 times what India attracted. This year promises to be better still. Beijing reported that 2013 FDI was up 7% from 2012 for January-July.
Why are the captains of global industry pouring so much cash into an economy with so many problems? Some answers can be found in a lengthy China report that superconsultant McKinsey & Co. published this summer. McKinsey is not infallible. But it does reflect as well as anyone could the consensus thinking among the global corporate elite.
McKinsey basically buys, with some caveats and qualifications, the idea that China can pull off the grand pivot it is undertaking from a poor country driven by low-cost manufacturing to a middle-income nation relying much more on services to, and consumption by, an enriched population. Manufacturing will land softly as the loss of cheap-labor advantage is offset by innovation that pushes China up the value chain. Infrastructure spending will remain prodigious for another decade at least, as those 70 new airports and much more come online. Trillions in national savings will start trickling through to consumers in the form of credit, financing everything from Gucci bags to condos. Cities in the Chinese interior will repeat the development explosion already experienced on the coast, as 300 million more people migrate to urban areas.
Does that mean you should rush to your terminal and load up on Chinese equities? Not necessarily, although the benchmark has had a 17% bounce since late June. As in other emerging markets, the most vibrant companies in China are tough to access because indexes are dominated by lumbering and nontransparent state-owned giants. The top 10 holdings of the SPDR fund include three of the “Big Four” state banks, an insurance company, and three government oil companies. Lither private firms have been damaged by an array of product-related and governance scandals, from poisoned milk to imaginary timber leases. The Global X China Consumer ETF (NYSEARCA:CHIQ) offers direct exposure to the country’s great income leap through companies like Great Wall Motor Co. (HKG:2333) or Tsingtao Brewery (HKG:0168). But it has outperformed GXC only marginally.
It does mean that the current image of a wounded China with its wheels falling off is no more realistic than yesterday’s image of an invincible China that would consign the Western world to the dustbin of history – at least according to the CEOs who actually have to bet on these things.
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