Pig out on China?

Fri 08 Feb 2019

By Brian Dennehy

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For the last 40 years the West has been mostly negative on prospects for China – and been proved wrong. That is my long-held view, and was also the view expressed by one Anglo-Saxon fund manager. As the Year Of The Pig dawns, might the negativity be right this time?

For the last 40 years the West has been mostly negative on prospects for China – and been proved wrong. That is my long-held view, and was also the view expressed by one Anglo-Saxon fund manager. As the Year Of The Pig dawns, might the negativity be right this time?
First here’s a quick recap. In TopFunds Guide of July 2018 we showed the two charts below to highlight the huge gap which remains between China and the US.
Per head of population the size of the Chinese economy is still just $7,593, compared to the US at $54,629 - more than 7 times bigger. This disparity is even greater if you consider disposable income per head, which is more than 13 times greater in the US.
Clearly there is still considerable room for China to grow - and the Chinese know it. That growth will take time, and need focus and strong leadership. This is why President Xi is now effectively president for life.
This gap remains despite the rise of China over four decades, in the words of the World Bank:
China has experienced the fastest sustained expansion by a major economy in history – and has lifted more than 800 million people out of poverty
China’s ongoing ambition is what worries the US, and the persistently negative narrative on China is very much US-led. Apparently, China has incurred a “slump” and a “is in the grip of a credit crunch”. There is always a “crash” or “meltdown” just ahead.
Much of the recent comment is around the issue of debt. It will surprise many that the amount of government debt compared to the size of the economy (GDP) is one of the lowest in the world – so the government has considerable slack, deep pockets, to step in when necessary – that simply doesn’t exist in the indebted West. It is the speed of build up in some forms of private debt which was a worry in recent years. The Chinese authorities well understood this, so started clamping down. Some poor companies went to the wall, property values sustained by a debt pile fell away, and economic growth slowed a bit. 
It’s not a catastrophe – but it is an economy being well managed, or as well managed as any government can do such things with any precision.
What about that pesky trade war? China used to be very much an export-led economy – no longer. Net exports are less than 2% of China’s economy today. Of goods exports, those to the US represents just 15%. And it is not easy for a US company to quickly or easily find alternatives due to higher import tariffs. In fact the quickest impact is higher prices for US consumers.
With China (in fact with any longer term investment opportunity) you want to consider the reasons for longer term optimism on the one hand, and, on the other hand, whether todays prices represents a decent entry point.
On reasons for optimism, the two graphics above highlight potential, but not how it might be achieved. Let’s look at that. This is what a fund manager said after a recent China visit:
Recently I went to China and tried to go for a business lunch. First of all I couldn’t order a taxi because I didn’t have the right hailing app.
I got to the restaurant and couldn’t order a meal because I didn’t have the right app downloaded on my phone.  I finally downloaded the app and managed to order my food but split the bill with the table of 15 next to me!
Coming to paying was the hardest part. No one takes credit cards in China… they looked at me like I was a medieval knight who had just walked through the door trying to pay in ancient coins.
E-payments in China were about $17trn last year, about 50 times bigger than mobile payments in the US.”
In some key technological areas (though not all) China is visibly way ahead of the West. This is what drives the trade war, and friction with, for example, Huawei, the Chinese telecoms supplier (something to which we will return).
China wants to lead the world in technology. So does the US. But they both can’t be leaders.
For a nationalistic inclined US president, this is a worry. Yet in the long run neither President Trump nor anyone else will be able to contain China in any significant way. One day Trump will be gone. But the leadership in China will persist – no electoral cycle distractions for them.
Do they have the expertise to fulfil this ambition? You bet. These are the countries with the greatest number of science, technology, engineering and maths graduates:
          China:                   4.7m
          India:                    2.6m
          US:                       568,000
          Russia:                 561,000
          Japan:                   195,000
China represents a vast clustering of talent. This is already reflected in their spending on research and development (R&D). China now spends more on R&D than Europe, and in 6 years could be spending more than the US and Europe combined. Such innovation drives growth.
As investors, we can access that potential relatively cheaply right now. The gloomy sentiment hints at that, and this can be observed within China as well as the Western press. For example, the enthusiasm of domestic investors has clearly waned, as has the enthusiasm of company CEO’s for floating on their stock market. This negative sentiment is reflected in the valuations.  
For example, Invesco are very encouraged by the value they are finding. Valuations are nearly 40% lower than in the US, and 20% cheaper than Europe. Another fund manager talks of some China shares being “extraordinarily undervalued”.
In addition, demand for Chinese shares will naturally increase this year. For example, many fund managers mirror the indices and China’s weighting in the MCSI ALL-Country World Index is just 3.5%, despite being 15% of the world economy. This is set to be increased in September of this year – it can only benefit a bounce from current levels.
Our strong inclination is to drip-feed monthly into China rather than immediately commit lump sums. This means you don’t have to worry about market timing. If there are market falls some months you simply buy more - and your overall average buying price reduces. So if you have £10,000 to commit, drip it into your chosen fund month by month over 6 or 12 months, for example.
The China fund sector is a small one. Two of the most consistent funds over the last 10 years are Invesco Hong Kong and China and Fidelity China Focus.


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