Six Reasons to Buy China
by Justice Litle
Is it time to buy China yet? Two weeks ago we noted that India looks like a buy. After bottoming out in July, various India exchange-traded funds (ETFs) are now trading at multi-month highs.
Shanghai, though, continues to look ugly. The Chinese stock market has been a downer for all of 2008. Even with the Olympics finally here, the mood hasn't brightened yet.
As with India, a number of factors came together to hit China hard. But also as with India, a bottom could be just around the corner. Here are a few reasons why China is shaping up to be a buy. Not yet, perhaps, but soon.
Reason #1: The Silly Season Is Over
Chinese investors went through a mania phase last year. There were tales of lines half a mile long snaking out from the doors of the local stockbrokers. In April 2007 alone, nearly 4.8 million new trading accounts were opened in China -- more than the prior two years combined.
All these new buyers led to a silly season for Chinese stocks. You could see it in the difference between Shanghai A-shares and Hong Kong H-shares...
At one point, companies with dual listings in Shanghai and Hong Kong were getting as much as an 80% premium on the A-shares price. This was a reflection of Chinese capital controls -- it's still tough for mainland Chinese to get their money out -- and naive buyers who wanted to play at any price.
Now that the frenzy has subsided, real values are starting to show up again. The hot money has burned itself out, providing opportunities for those who see longer-term value and aren't out to just flip a quick buck.
You see this pattern play out over and over again when a new opportunity comes to a place. Investors get excited and lose their heads, they push things way too far, and then the market comes crashing back to earth.
That's when the patient players get interested.
Reason #2: Oil Is Coming Down
As of this writing, crude oil is more than 20% off its near-term highs. It looks like oil could be heading for the $100 mark -- a possibility we pondered in "What If the Price of Oil Implodes."
One of Asia's greatest challenges has been keeping a lid on inflation pressures. It's not easy to grow like crazy without seeing the price of basic goods and services rise too quickly.
Oil closing in on $150 a barrel threatened to swamp Asia with inflation on a local level -- as the price of transport, food, and fuel went up – and also to cut into export profits as shipping costs rose.
With oil backing off, China and India can breathe a little easier. The fear that high-priced oil might kill the Asian miracle is lifting. That gives them more time to tap alternative energy solutions and build economic strength at home.
Reason #3: The Locals Are Optimistic
The news reports mostly focus on the bad things -- civil unrest, government crackdown, pollution and so on. That's the nature of the beast mostly for the most part, good news isn't as interesting as bad.
But a recent survey from the Pew Research Centre shows that most Chinese feel positive about where their country is headed. According to the survey, 86% are "content with the country's direction." (That's up from just 25% six years ago.)
Perhaps even more surprisingly, six in 10 Chinese reported being satisfied with their jobs. And 70% were in favour of China's shift toward a free-market economy.
The biggest concern in the Pew Survey? Rising prices. But that concern is addressed by the fact that oil is headed down these days – not marching higher as it had been for most of the year.
Reason #4: The Growth Is Still There
China has had an amazing run, growing its economy at a near double-digit pace since the early 1980s. But the dragon isn't done yet -- not by a long shot.
Global Insight, an economic consulting firm, forecasts that China will overtake the U.S. as the world's largest manufacturer in 2009. This is as much because the U.S. base is shrinking, even as China's is growing... but that still counts as an eye-opening stat.
Plus for the longest time, China was seen as the world's source for low-tech goods. Chinese factories were known more for sneakers, trinkets and cheap plastic toys than items of real value.
That's all changing now as China moves up the quality food chain. Now we are seeing savvy companies like China Medical Technologies on NASDAQ produce some of the most sophisticated high-tech devices in the world. As China gets better at enforcing intellectual property laws, its high-tech skills will only increase... and profit margins, too.
Reason #5: Personal Savings and Domestic Demand
Perhaps, even more impressive than China's long-term growth rate is the personal savings rate.
Americans spent more than a dollar for every dollar they earned in 2006. The US savings rate actually went negative. The Chinese, meanwhile, salt away 35 cents for every dollar they earn.
Just imagine how much extra money you'd have on hand if you'd managed to save 35% of your income, year in and year out, ever since you started working.
Then just think of all the things you could buy with that cash.
Part of the reason the Chinese save so much is because there's no real social safety net. But that's changing, too: As the Chinese economy evolves, things like insurance and healthcare and retirement plans grow more affordable.
The upshot is, at some point, China's big savers will feel a little bit more comfortable spending some of that cash they've saved up. And the newly minted middle class in China are already taking a hard look at things like cars, air conditioners, washing machines and so on.
As local economies grow, the locals themselves feel more comfortable spending a portion of their ample savings. That in turn leads to more domestic growth, which leads to a more positive outlook, which in turn increases spending.
Chinese domestic demand is headed into a virtuous cycle that could run for decades.
Reason #6: Huge Foreign Reserves
In balance sheet terms, China is rich... massively rich.
We've already seen what can happen when cities and counties go bankrupt. The residents of Orange County, California, got a nasty taste of that. Jefferson County in Alabama was on the brink this year, too. (As with Orange County in 1994, they took on some really dumb trades.)
So it's not good when some regional authority – be it local or national – is running short on cash. China doesn't have that problem. If anything, it has the opposite problem. Economist Brad Setser estimates that China has somewhere between $2.3 trillion and $2.4 trillion in excess reserves.
That's a lot of dough... enough to make a 20% down payment on the entire US economy! And hundreds of billions more roll in every quarter.
Point being, money can't always prevent bad things from happening. But it sure can fix a lot of things. If China has to take extra steps to keep economic growth on track or keep the domestic demand side humming, it certainly won't be stymied by lack of funds.
Not Just Yet, But Soon
So there you have it. For the six reasons above (plus a number of others not mentioned), China's long-term outlook looks very strong.
Because of that, and because of the depressed state of Chinese equities right now, some China plays look more favorable than they have in years. I wouldn't pull a long trigger on any of the China ETFs just yet. There's plenty of time for the technical side of things to firm up first. But I would definitely keep a close eye on things.
One last quick thought: One of the ironies of markets is that the biggest profits often come not when a good situation turns itself into a great situation... but rather when a bad situation becomes good.
This is because investors are so naturally predisposed toward optimism. So, when "good" becomes "great," some of the optimism premium was already built in, and the upside isn't always as strong (until the blow-off phase arrives).
But when bad morphs into good, or even simply to "less bad," there is room for large (and safe) gains, as renewed excitement creeps in after an extended absence.
That's where it feels like we are with China – waiting for the bad to turn good, which it soon could.
And aside from big picture trading opportunities, there are a number of smaller Chinese growth companies -- many of them traded on US exchanges – that look very appealing here and now. Stay tuned!
The writer is the editorial director of the Taipan Publishing Group which publishes a free e-letter, the Taipan Daily at www.taipanpublishinggroup.com
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