By GRAHAM FROST 01/06/2007
China has been in the news even more than usual this week as its stockmarkets dipped by around 6%. This came in the wake of a warning by former US Federal Reserve Chairman Alan Greenspan that a bubble is forming and the Chinese Government tripling stamp duty (on share trades) from 0.1% to 0.3%.
| "This latest setback appears to be a storm in a teacup." |
This latest setback appears to be a storm in a teacup and, unlike earlier in the year, other World markets have not fallen in sympathy. However, China may not be out of the thick of the woods yet so it’s worth trying to understand what is driving the underlying markets and the risks involved.
In simple terms there are three routes to investing in mainland China companies:
‘A’ Shares – Listed on the Shanghai Stock Exchange but access tends to be limited, especially for foreigners.
‘B’ Shares – Listed on Chinese stockmarkets and open to both local and foreign investors.
‘H’ shares – Listed in Hong Kong.
As the chart below shows, ‘A’ and ‘B’ shares have raced ahead over the last year so it’s unsurprising that these have borne the brunt of this week’s falls.
One of the reasons that domestic ‘A’ and ‘B’ shares have surged to such levels is the seemingly endless appetite that Chinese investors have for shares. Chinese interest rates are lower than inflation so there’s little incentive to invest in cash or bonds over shares. However, reports suggest that most Chinese investors are indiscriminate as to what they buy and some individuals are even re-mortgaging their homes or cashing in their life’s savings to invest. Combine this with foreign investors seeking exposure to ‘B’ shares and it’s little wonder Greenspan is worried about a bubble, especially as ‘A’ and ‘B’ shares valuations look rich compared to ‘H’ shares.
While it’s highly likely short term volatility will persist, long term prospects for China remain promising. It is already the fourth largest economy in the world (after US, Japan and Germany) with many economists predicting it will become the largest over the next 15-20 years. Importantly, the rate of annual GDP growth has also been quite stable at around 8-10% for the last 15 years, around three times higher than typical Western economies.
Thanks to a population of 1.3 billion, over one fifth of the World’s total, the scope for growth in domestic demand is staggering. For example, credit card ownership grew by 70% last year and car ownership by 30%. Both are starting from a low base, just six in every hundred Chinese currently own a car, so it’s unlikely these rates of growth will slow for some time yet. It’s worth remembering that China’s GDP per capital is still just US$1,703 (placing it 110th in the World), hence spending is still very low by Western standards, but the sheer scale of the population nonetheless provides a welcome backbone to the economy.
| "While it’s hard to envisage China falling over long term, there’s plenty of potential hiccups along the way." |
While it’s hard to envisage China falling over long term, there’s plenty of potential hiccups along the way. Despite going through rehab, China’s banks still face a big threat from bad debts. Chances are they’ll shrug these off and eventually prosper, but it may not be an easy ride. Currency revaluation (expected to continue at 4-5% a year against the US$) could hit exports, although if the previous experience of Japan and Taiwan are anything to go by the broader market could rally in spite of the loss of competitiveness. Wage inflation of 13-15% is also a threat given China’s big advantage on the World manufacturing stage is low labour costs. It may be that increased automation and efficiency can offset this medium term, but it could cause problems. We should also not forget the potential for hiccups arising from the legacies of the communist order: question marks over property rights, corruption, internal political pressures, under investment in public services, energy shortages and an inefficient fiscal system.
In summary, it is well worth considering exposure to China within you portfolio, either via a China specific fund or more practically an Asia Pacific or Emerging Markets fund. If you can stomach the roller coaster ride and invest for 10 years or more it’s likely you will prosper.
You can view a list of rated funds here.