The McKinsey Quarterly presented the opinions of its resident director in Shanghai last week. They make interesting reading, but I will focus on the first of ten observations and predictions.
"Government policies will spur consumption and investment. These moves will compensate for declining exports and a slumping housing market. To boost consumption, policy makers could pull a number of short-term levers, including tax breaks and rebates, and are likely to raise the minimum wage further."
From afar, I agree with this prediction, not only for 2012, but also for the foreseeable future. Chinese policy will encourage consumption and the formation of a Chinese consumer economy. This is because China's leaders do not merely want China to be the world's source of cheap imports. They want China to be the engine of the world economy and the most powerful nation. They know they can get to that position only if the Chinese people flourish economically, and that means rising wages and a growing internal consumption economy. The process will take many years, but I believe the Chinese will be successful in becoming an affluent consumer economy and that this will be evident year by year over the next decade and beyond.
If I am correct, that is very good news for the global economy because the Chinese consumer will join the American consumer as the largest source of final demand based on earnings, and it is final demand that is based on earnings that spurs long-term economic expansion. (Final demand based on borrowing by households to buy short-term goods or services mostly moves demand from the future to the present.) Although the problems of the western economies owe much to China's economic policies of the last 20 years and the low cost of Chinese labor, that negative feedback loop for western economies will reverse as the growth of Chinese affluence gathers pace.
I focus on China rather than India or Brazil or Indonesia or Russia both because China is so large and because its leaders have such a clear view of where they want their country's economy to go. The other large and growing economies simply are either not so large or not so clear on what they are trying to accomplish. But they, too, will play a growing role in increasing global final demand. The comparative affluence of Chinese consumers will inspire workers all over the globe.
Increased Chinese affluence and consumption still will not mean that an American or Italian without skills can get a good job. Local unskilled jobs may be available, but they will pay a pittance compared with skilled jobs that are in global demand.
The developments in China will be good news for well-run, competitive companies everywhere that stay up-to-date in their product and service offerings. The developments in China will not be good news for legacy companies with old technologies because the new Chinese (and other) competitors will beat the pants off them.
These factors make global investing more important than ever. But the risks concerning disclosure standards in China and other emerging markets remain significant. Although there are plenty of financial scandals in the U.S. and Europe, the sheer number of scams and fraudulent financial reporting in China and other emerging markets is daunting. For that reason, I remain convinced that well-run mutual funds are the soundest way to invest in those markets. I also am afraid, however, that any one fund could be the victim of a manager's misunderstanding of the local market. Therefore I am an advocate of owning more than one fund in each market.
In China, there are closed end funds like China Fund (CHN), Greater China Fund (GCH), and Templeton Dragon Fund (TDF), all of which have good records over the last 10 or 15 years, as well as open end funds like Matthews China Fund (MCHFX) and Fidelity China Fund (FHKCX). Which of these (or others) one should own depends on one's assessment of the managers and the fees associated with each one. Fees for China funds tend to be on the high side. These funds should be long-term investments, since, although China's growth may be fairly steady, the market prices of Chinese companies ebb and flow in quite a volatile fashion that is difficult to predict. Now probably is a good time to invest in China, however, because its stock markets are not currently near their high points. I recently added to my holding of China Fund, for example. (I also recently added to my holding of the Morgan Stanley India Fund (IIF), which has underperformed in recent years, after good performance over the previous decade or so.)
Long-term bullish sentiments could, of course, lead one to invest in an S&P fund such as SPY. But suppose we want better than market returns and think we have some stock-picking talent or that we can avoid the worst-performing companies by selecting individual stocks. We might opt to do our homework on individual stocks instead.
Long-term bullish sentiments would make me an investor in American companies that I think can take advantage of demographics and have the capacity to keep up technologically in their fields. Ford (F), for example, now seems to have the determination and the management to produce good cars. Regardless of whether it can garner a meaningful slice of the Chinese market, global economic growth should enable Ford to flourish.
Companies that own oil in the ground also should flourish because with global growth should come continuing increases in the price of oil-or, looking at the downside, at least not significant decreases. Energy SPDR (XLE) might be a way to invest in the oil market in a diversified way. But XLE is dominated by the major oil companies that earn most of their income from production and marketing, not from ownership of oil in the ground. Although over 90% of the world's oil now is owned by sovereigns rather than publicly traded companies, there are some American companies, such as Marathon (MRO), Conoco Philips (COP) and Apache (APA), that own large amounts of oil in relation to their market capitalizations.
Oil also is a good hedge against dollar inflation or dollar devaluation. Although gold is hedge against inflation, I like oil better because I believe it is a truer hedge that is not dependent on mass psychology.
There even is an argument that Apple (AAPL), as great as its recent appreciation has been, will continue to flourish due to the expansion of the global market. Although classically one might look at Apple and say that it must soon become a "mature" company in terms of growth, if the global market for Apple's products is going to continue to expand fairly rapidly, then Apple may be quite fairly priced with room for growth.
What should we say of Whirlpool (WHR)? Will it get better market penetration in the markets of the East? Will it be able to keep up technologically? Is it becoming a nimbler company through its plant consolidations? Or is it a lumbering American legacy company that is stuffed with legacy brands that have little cachet in the world of the 21st century? I own it. Should I? Or is there a better way to play the world's growing appetite and capacity to buy washing machines, refrigerators and similar appliances? LG (not listed in the U.S.) and Samsung (not listed in the U.S.) are formidable competitors in the home appliance field, as are some of the European competitors such as Bosch (not listed in the U.S.) and Siemens (SI), as is GE (GE), but all of them are in so many product markets that they are far from a pure home appliance play on the developing world's demographics. I wonder, is there such a thing?
The fundamental point is to visualize the world economy as having the capacity to overcome the currently obvious problems in real estate markets and sovereign debts. We have heard so much bad news in the last four years that we are inclined to be listening for the next shoe to drop rather than the next source of good economic news. If you believe in the capacity of markets to recover for the simple reason that markets are made up of people and people are pretty resilient, then perhaps the time has come to look for a better global economic climate. If China leads the way, as the McKinsey director in China suggests it will, then I think that time may be at hand.