Market Memo: Stop worrying so much about China
There’s been an awful lot of hand-wringing over China, with almost every disappointing economic report out of that country unnerving already jittery markets. Well, I have one word for all of you who find yourselves on edge with every release emanating from the Middle Kingdom: Relax.
A visit to that country and 19 companies there by a member of our international equity team found widespread agreement that this year’s second half should be better than the first, and 2013 should be better still. It’s expected the central government will continue nudging interest rates lower while picking up the pace of stimulus. Nothing along the scale of the broad-based $586 billion post-2008 crisis package, mind you. The consensus among managers, consultants and investors there was that rescue package was responsible for both the inflation and real estate speculation behind China’s slowing.
This time around, it’s anticipated that Chinese authorities will favor more targeted stimulus, most likely by frontloading some projects from the country’s latest five-year plan, not only related to infrastructure but also energy efficiency, education and health care. Certain parts of the government already have restarted their investments, with both nuclear and rail investments on the rise. Overall, the five-year plan envisions some $315 billion of projects, most of which can—and probably should—get started earlier to meet burgeoning domestic needs.
This more subdued approach suggests China’s recovery may be slower than was the case in 2009-2010. It may take at least a quarter for the economy to show improvement. Nonetheless, these efforts to spur growth should be very positive for Chinese equities, with a nod over the next few years to companies involved in automation, health-care, autos and auto-related capital expenditures, subway and regional rail systems, water, education and green energy. It helps that, in terms of historical valuations, Chinese equities look very attractive. At 6.8 times trailing P/E, the Hang Seng China Enterprises Index (HSCI or H-Shares Index) is scrapping the bottom of its historical valuation, trading in the 99th percentile relative to its historical position. The Shanghai Stock Exchange A-Share and MSCI China indexes bear similarly low valuations.
Growing and wealthier middle class undergirds domestic growth
Moreover, despite what some recent statistics suggests, China’s economy already is on the mend. Inflation is in check. Chinese inflation has come down from over 6% to 1.8% over the past 12 months, while the lending rate has fallen from 6.50% to 6% over the last quarter. Both lower inflation and lending rates should support growth in the next 12-24 months. Also lower inflation should support future interest rate cuts. Loan growth is already picking up. And residential construction looks poised to reaccelerate, as rising sales have sent housing inventories plunging, creating budding shortages. This is particularly true in the upper-mid to high-end of the housing market, where demand is soaring along with the Chinese middle class, which is projected to add 250 million households the next eight years. That’s the equivalent of 750 million people, roughly 2.5 times larger than entire U.S. population. And these households don’t just want homes. They want cars, clothes and goodies, too. Some analysts believe Chinese demand for autos could peak at 40 million vehicles annually, versus the 15-to-16 million now.
Yes, a messy Europe remains a problem for China, as does a plodding U.S. recovery. But the China story increasingly is one of robust and growing internal demand, with all the key metrics pointing to an acceleration of this trend. So worry, if you must, but don’t get caught short on China, where the next chapter looks to be a promising one.