When you look at China, are you looking at its past or at its future?
Many investors are pessimistic about China’s economy, largely because they don’t realize how much the country’s economy has changed. China’s old economy looks weak. Exports were down by about 3 percent for the year through October, compared with an increase of 6 percent a year ago. Industrial production was up 6 percent, versus 8 percent a year ago. Fixed-asset investment has gone up 10 percent, down from a 16 percent growth rate during the same period last year.
But are those the parts of the economy you want to focus on or invest in?
Exports, for example, haven’t contributed to gross domestic product growth for the past seven years. I estimate that only about 10 percent of the goods rolling out of Chinese factories are exported. China largely consumes what it produces. Manufacturing is sluggish — especially in heavy industries such as steel and cement — as China has passed its peak in the growth rate of construction of infrastructure and new homes. Nonetheless, manufacturing has not collapsed: A private survey reveals that factory wages are up 5 to 6 percent this year, reflecting a fairly tight labor market, and more than 10 million new homes will be sold in 2015. More important, few investors recognize that this is almost certain to be the third consecutive year in which the manufacturing and construction part of the economy will be smaller than the consumption and services part. China has rebalanced away from a dependence on exports, heavy industry and investment. The country has become the world’s best consumption story.
Understanding this dramatic shift is key to assessing the impact of China on the global economy, and on your portfolio.
Even if you never own a Chinese equity, you are effectively a China investor. China accounts for about one third of global growth — greater than the combined shares of the U.S., Europe and Japan. This helps explain why U.S. exports to China have increased by more than 600 percent since the country joined the World Trade Organization in 2001, while U.S. exports to the rest of the world rose by less than 100 percent. This rebalancing has been driven by Chinese consumers, with consumption accounting for 58 percent of GDP growth during the first three quarters of this year.
Shrugging off the mid-June plunge in the stock market, real (inflation-adjusted) retail sales growth accelerated to 11 percent in October, the fastest pace since March. Unprecedented income growth is the most important factor supporting consumption. In the first three quarters of this year, real per capita disposable income rose by more than 7 percent, while over the past decade real urban income rose 137 percent and real rural income rose 139 percent. Some of that increase was driven by government policy. The minimum wage in Shanghai, for example, rose 187 percent over the past ten years. For comparison, in the U.S. real per capita disposable personal income rose by about 8 percent over the past ten years.
And it is worth noting that one reason that the fall in the mainland’s A-share market didn’t depress Chinese consumers is that although the market is down sharply from its recent peak, the story isn’t quite as bad as some make it out to be. As of December 10 the Shanghai Composite Index was down 33 percent from its June 12 peak. But the index was up 6.82 percent from the start of the year and up 17.6 percent from a year ago. Thus the Shanghai Composite is outperforming the S&P 500 index on a year-to-date basis, with the S&P down 0.3 percent as of December 10, as well as on a one-year basis, with the S&P up 2.49 percent over that period.
We need to accept and understand, however, that the necessary restructuring and rebalancing of China’s economy, along with changes in demographics, and the law of large numbers — in this case two decades of 10 percent growth — does mean that almost every aspect of the economy will continue to grow at a gradually slower year-over-year pace for the foreseeable future. The strong consumer story can mitigate the impact of the slowdown in manufacturing and investment, but it can’t drive the growth rate back to 8 percent a year.
So while the growth rates of most parts of the economy are likely to continue to decelerate gradually, keep in mind that this year’s perceived slow pace of 6.9 percent growth, on a base that is about 300 percent bigger than it was a decade ago, when GDP growth was 10 percent, means that the incremental expansion in China’s economy this year is about 60 percent bigger than it was back in the day. In other words, the lower growth rate is generating a larger opportunity.
Andy Rothman is an investment strategist at Matthews Asia in San Francisco.
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