Buy China: It's Actually Benefiting from Global Recessions 14 comments
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An important lesson from today’s financial crisis is that while it is a time of great pain, it is also a time of great opportunity. Historically, financial crises transferred money to countries with stable economic growths. For instance, during the 1990s, the Asian and Latin currency crises caused investors to panic, thus withdrawing all their investments there and instead channeling the money into the United States. Consequently, we witnessed the greatest bull market in America’s history. Now, all the major economic forces — America, Japan, and Europe — are suffering recessions. Only China is the last remaining safe haven. This article will analyze Chinese economy and how it is benefiting from global recessions.
China’s Economy
The financial markets in China are sound and solid. They have an average of less than 2.5% bad debt in total loan. Moreover, in the last year, domestic savings increased 26% to 4.8 trillion, while debt remained only at 2.9 trillion. Comparatively, savings increased from 46% of total GDP in 2007 to 52% of total GDP in 2008. These are huge numbers.
While those statistics are impressive, of more importance are the macroeconomic policies the government is pursuing. In the next couple of years, as social security keeps improving, people will be more willing to invest in riskier assets than before. Moreover, the government has been loosening monetary policies to increase lending. Due to the Central Bank's basis of operating (on very low leverages (approximately in a five to one ratio), the government also lowered the reserve requirement to encourage banks to operate on a higher leverage ratio. In Chinese banks, for example, lending activity increased dramatically in the first two months of 2009. Partly, this is due to the huge stimulus package.
The US home prices declined because the US economic bubble busted. This situation is unlikely to happen in China. During 2001 to 2003, real estate consisted only 8% of GDP. While its price declined for 3 straight years, GDP still grew at 8% annual rate. In 2008, real estate sector consisted only 5% of GDP. The home price has decreased by 20% already, yet the GDP is still expanding. China also will not have high default risk, according to Vanke (the largest real estate developer in China), as 56% of home buyers paid cash-down for the whole house.
Shifting Focus and Emphasis as Exports Decrease
The decrease in exports will necessitate Chinese firms to focus more on domestic consumers. As more firms try to maximize domestic consumption, this process will drive down the price of domestic products and increase the Chinese consumers' buying options. Instead of producing cheap products for developed countries, Chinese consumers will enjoy the low price themselves. Hence, the global recession is giving China an opportunity to rebalance its economic structure and relocate resources more efficiently.
Furthermore, the global recession is allowing China to expand without the need to worry about inflation. This is a case of history repeating itself — where the 1990s global financial meltdown similarly allowed the US to enjoy a very long economic boom without the threat of inflation for ten years. At that time, America was the big country with a healthy economy. Today, it is China. And as the global economy slips deeper, the demand for resources will drop significantly and drive down the cost of most products. In addition, the large layoff in developed countries will let China keep its talented workers and hire more skilled foreign workers.
Continuous Potential
While China’s GDP is ranked second, its per capita GDP is only ranked 104th in the world. As a result, China still has a very good labor-intensive advantage; coupled to the increasing university attendance by its citizens, this develops human capital. This advantage will allow China to continue gaining on market shares from other countries.
At the same time, China is beginning to gain market share in high-end products and services, with "China’s Silicon Valley" experiencing more than 10% growth in 2008. It is also assisted by major government acts too, with former President Bush signing an agreement in 2008 that increases technology exports to China. The trickle down effect is ensuring that China and the Chinese are learning new technologies and management methods at a faster pace than ever before. As more companies look for new revenue sources outside of their own depressed economy, big international companies like GM and IBM are investing heavily in China to attract potential customers.
In the next three years, China will lead the world economy to recovery. Companies presently want to divert their resources to a stable and sound economy. In this context, China is almost the only big economy that can provide investors confidence during this global financial meltdown. Also, by increasing domestic consumption, China will continue to expand on imports from other countries, with China just recently signing contracts with England to double imports in next two years.
We can see changes in China in various aspects. China’s policies are becoming more transparent, its human rights continue to improve, and its social security is also under reconstruction. However, we also need to be patient to see the changes take affect. With all these improvements, allied to its ever growing economy, China is becoming a force to be reckoned with.
Buy China Stocks (FXI, GXC) - They Are Cheap
FXI and GXC p/e ratio is only 13.5 with a positive earning growth. China stocks average P/E is 35. Hence, as long as the P/E ratio of China is around 15-25, China stocks are good buy.
Compare this to the S&P 500 which also has a 13.5 P/E ratio with a negative GDP growth next year. Based on the S$P 500 earning reports, the earning is even lower than 1992 earning. According to the earnings report, total US earning are at the level of 1991, where the S&P 500 was only 450 point. Based on the earnings report on S&P 500, the stock market still have 20%-40% downturn.
Precautions About the Expanding Economy
1. The global recovery in 2010 might raise inflation worries in the increasingly expanding China. The interest rate needs to be raised then to combat inflation. The second half of 2009 will be a good time for a rate hike.
2. Investment in education, social security, and the medical systems are too small compared to infrastructure investment and military spending. China should not repeat the same mistake that Japan did 20 years ago. Established studies illustrate that investments in education and social service have far more impact than infrastructure investments.
3. Housing prices in big cities are too high for the average person. The price needs to lower further. There should be no dramatic price increases, like that in Japan during the 1980s which brought down the whole Japanese economy.
Disclosure: Author holds long position in FXI, GXC
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This article has 14 comments:
The rosy outlook you have will be impacted by the fact that much of China's GDP depends on exports. A corollary to that is that if the developed world gets smart about "free trade" it will NOT help China.
It is hard to say human rights are improving as the occupation of Tibet goes into its 50th year.
While I grant that the chinese economy grew very rapidly between 2004 and 2007, clearly the data from 1998-2003 is absure.
Frankly, I don't think the chinese government (or anyone) really knows how fast (or slowly) the chinese economy is growing.
The only certainty is that, having stated on many occasions that it has a target of 8 percent growth and it is confident of meeting it, they government will report that the economy grew at slightly more than 8 percent at the end of the year.
Very good run down on China. I agree wholly. Thank you for you work. Please keep it up.
I also agree with Mad Hedge Fund Trader: the EMs are where the money will be made over the next ten to twenty years. That's the very reason why all of America's largest companies are piling into China as fast as they can.
All investors will have to face it soon, as wise ones already have: you must invest where the government is pro-business, as in China, not in America which has become anti-business—and I fear it's only just begun!
It's sad to say, but even France is currently more pro-business than the US.
I don't like ETFs, though, so I'm invested in these individual stocks in China: PTR; CEO; CHL; SOHU; NTES; PWRD; HNP; YZC.
A few other companies I own outside the US are these: POT; KHD; PKX; STO; RIO; NOK; FTE; RTP.
I'm not at all recommending these, but simply noting them to show I'm putting my money where my mouth is, as I think all investment authors should who are able to by law.
On Apr 02 09:20 AM rm96696 wrote:
> Once again the writer takes Chinese data a face value. He writes
> that Chinese gdp grew 8 percent per year between 2001 and 2003 despite
> falling house prices. Is he sure? Has anybody noticed that the chinese
> publish data almost in real time. The only country as quick is singapore,
> but they only have to cover one city...
>
> While I grant that the chinese economy grew very rapidly between
> 2004 and 2007, clearly the data from 1998-2003 is absure.
> Frankly, I don't think the chinese government (or anyone) really
> knows how fast (or slowly) the chinese economy is growing.
>
> The only certainty is that, having stated on many occasions that
> it has a target of 8 percent growth and it is confident of meeting
> it, they government will report that the economy grew at slightly
> more than 8 percent at the end of the year.
The report says that, without further market-oriented reforms, the stimulus package will not only fail to achieve its goal but will also store up long-term problems. In need of change, it says, are government controls on prices of water and power and government monopolies in industries such as telecoms, railways and aviation. It calls for faster financial reforms such as encouraging the development of non-state financial institutions, freeing controls on interest rates and allowing the yuan to float."
The Economist March 19th, 2009
One note on ETF, make sure do not buy the 2X, 3X leverage ETF. Those ETF is only for short term trader. The leveraged ETF designed to lose money in the long term.
On Apr 02 08:34 AM Tom B wrote:
>
> It is hard to say human rights are improving as the occupation of
> Tibet goes into its 50th year.
>
On Apr 02 09:41 AM ArtfulDodger wrote:
!
>
> It's sad to say, but even France is currently more pro-business than the US.
Think about it for a moment. The vast fortunes that have been in the last two decades....where were they made? Not in teaching, engineering, or nursing. They were made in BUSINESS and its corollary service partners: law, banking, accounting.
Truly mad, indeed.
I agree with the popints in your article, but why settle for a mutual fund with a PE of 13?
There are some excellent China microcap stocks (whose numbers I trust more than American bank stocks now), with PEs of 2.
Look into CHGY (China Energy) for example.
In the last Q of 2008, they completed a major expansion of their power plant, including upgradeds that vastly increase efficiencies. They went from breaking even in the first 9 months of 2008 to making .09/share in the last Q.
EPS projections for 2009 at $55-$60/ton coal prices (conservative) are from .35-.40/share, and the stock is about .20/share right now for a forward PE of 0.5...yes, that's Zero Point Five PE.
Naturally volatility and risk are greater in an individual stock- especially a microcap, but for some risk capital, the rewards can vastly outstrip anything that FXI or CXC will return over the next 6-12 months.
Disclosure- I am long CHGY, and about 10 other China microcaps right now. Many are just now starting to move nicely based on fundamentals, but most remain vastly undervalued.
regards,
Or sell CAF to buy 2823.HK that still traded around par...
On Apr 02 10:38 AM Darren Jing Yu Jiang wrote:
> I wrote this article 1 month ago when the FXI was still around $25.
> Now China stock is a little risky to buy. My current target for Chinese
> GDP growth is 5%. In my prediction, China stock market will fall
> in the future due to slower growth. By the end of the year, Chinese
> stock market will move much higher when investor realize slower growth
> actually is not a bad thing.
>
> One note on ETF, make sure do not buy the 2X, 3X leverage ETF. Those
> ETF is only for short term trader. The leveraged ETF designed to
> lose money in the long term.