By Ed Leventhal
If we were to play a game of “Immediate Reaction” in which I say a word and you respond with the first thought that comes to mind, my guess is that when I’d say “China”, if you’re like many investors, you would respond “Slowing down their economy” or “Foot on the brakes”. At least, that’s how it appears to me every time I engage investors or analysts in a conversation about that all important country on the global landscape.
As I’ve indicated in several recent articles, I have been adding to my China exposure, mostly in the form of two ETFs, FXI and HAO. I’ve been doing this at times when the markets have seemed overly pessimistic about the impact of a “China slowing” which usually manifests itself when the central bank is performing some sort of policy tightening procedure….hiking rates, raising reserve requirements, extending reserve requirements that were meant to expire, and various forms of “moral suasion”. More often than not, the feedback that I’ve received whenever I make these comments typically questions my relative bullishness and wonders why I don’t see China as a bubble in the making, if not a bubble about to blow!
Earlier this morning, I read a fantastic piece for which I have to credit The Unconventional Economist for making publically and readily available to readers. It’s a letter from the CEO of a major residential development firm in China to his staff in which he spells out the optimistic and bullish case for China in the coming years. The Unconventional Economist notes that he himself has published several bearish articles on China, so this was presented in the interests of airing a balanced perspective. One doesn’t often see this kind of thoughtfulness and thoroughness of analysis, and for that, again, I credit and applaud The Unconventional Economist.
In response to the article, I made the following comments:
Thank you for sharing this. I have not read your bearish views on China to which you refer, but I will, since much of what is in Mr. LIEW Mun Leong's letter has been the backdrop for my bullish view (and portfolio positions) in China. I look forward to reading your 'other side of the story'.
I have been arguing many of the points made in Mr. LIEW Mun Leong's letter for some time, and often find ferocious rebuttals from China bears who don't feel compelled to go much further in their arguments than to say "it's a bubble about to explode". There is no doubt that speculation is driving price appreciation in the large, internationally known "household name" cities, but the vast majority of China still has a long journey ahead of it in terms of providing modernized and affordable housing. Furthermore, the "shrinking" of the country via the High Speed Railways is a meaningful, though admittedly not immediate, factor among longer term stabilizing forces to the housing supply/demand balance.
Finally, the Central Bank's attack on inflation, most worrisome of which is actually in the food sector, has been methodical and inclusive of many tools of monetary policy. The markets, however, appear to sell off every time there's even a hint of further action. Into those selloffs, I've generally been adding exposure to China. Growth there is real. And to ascribe it solely to a real estate bubble is to miss the generational transformation that is taking place.
So, I remain quite positive on China overall. That said, I’m not recklessly adding to my exposure unaware of the magnitude of risks that lay ahead. For example, in my overall investment framework, I weigh in several risk factors quite heavily….for example, it is possible that the central bank puts its foot on the brakes too hard and economic growth comes to a crashing halt. It is also possible that the scourge of food inflation is already at uncontrollable levels, and that civil unrest foments beyond the government’s ability to contain it ‘quietly’. It’s also possible that China, though relatively passive with regard to recent tensions between the Koreas, could change course and inflame an already simmering situation.
I am, however, far more optimistic about the growth prospects in China and about many of the demographic and cultural changes that are cited in the above referenced CEO’s letter. Given that, China has a place in my portfolio. And if the markets continue to view the China trade as having been played out, it’s likely that I’ll see that as an additional buying opportunity.
Does this mean that I view the bears as simply hibernating with the comfort of the “Immediate Reaction” responses to justify their position? Partly, yes, because those headlines, at a cursory level, are justifiably bearish. But partly no, in that a proper deeper dive into the Chinese situation does in fact produce an outcome that warrants meaningful caution.
Each investor will have to assess exactly where he/she stands on this issue of China valuation relative to its risks and conclude for themselves as to whether or not current prices reflect exit or entry points for their unique portfolio, financial and risk situations. It is my intent with this article simply to raise both sides of the issue and encourage investors to reflect on the package of issues before opining. Doing otherwise, regardless of whether you’re bullish or bearish, would arguably subject you to being dubbed a “bull in a China Shop”!
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