China is not having a "landing" of any kind. A better metaphor would be: It is having a hangover after a decade-long investment-fuelled boom. How bad is this hangover, what is the cure for China to wake up, and what are the investment implications? At Morningstar's recent ETF Invest event, Kevin Carter, CEO at Baochuan Capital Management, and Daniel Rohr, senior securities analyst at Morningstar, shared their contrasting views on China's economic outlook and investment opportunities.
Is China Overbuilt?
The biggest threat to China's sustainable prosperity is its unbalanced composition of growth. China's growth in the past decade was largely driven by investments, particularly real estate and infrastructure spending. But has China built too many houses and roads than needed? Rohr believes it has. China's National Trunk Highway System is already longer than the US Interstate System, while the US has three times more cars than China has. Statistics show that the average urban household in China owns 1.2 homes, which explains the anecdotal "ghost cities." Carter, on the other hand, is convinced that the recent price drop in China's real estate market is not because of oversupply, but affordability. China's real estate stocks have actually gone up a lot in the past 12 months even though the real estate prices are in decline. But both agree that a transition from an investment-led growth to a consumption-led economy is essential for China in the years to come.
How Hard Is the Transition?
The task is formidable, however. History has suggested that investment booms are often followed by debt crises. Many Asian countries have experienced similar investment-driven growth--such as Japan, Korea and Taiwan--and, on average, the growth in these countries fell from 12.8% in the boom decade to 1% in the post-boom decade. Consumption actually dropped when they began to make the transition.
Rohr holds that, in China, the wealth effect from a burst in the housing market is likely to be huge because real estate accounts for 41% of Chinese household wealth, compared with 26% in the US. People will feel poorer when their home prices drop, which will prevent them from spending more. Carter believes the concern is overblown. Looking at China from a big picture standpoint, one would be convinced that a country with more than 1 billion people is not going back to where it was. Hundreds of millions of urbanised people are not going back to the countryside, and their appetites for better goods will only grow rather than diminish.
Is China Underweight in Everyone's Portfolio?
How should investors position China in their portfolios? Carter believes that most people's portfolios have a severe underweighting in Chinese assets. If investors take an indexing approach to gain access to the market (the MSCI Emerging Market index, for example), China, the second-largest economy in the world and the most important driver for global economic growth, only holds approximately a 1.7% weighting in most investors' portfolios. Carter advocates a larger allocation to China in order to capture its secular growth trend. Rohr, on the other hand, points out that a country's gross domestic product growth actually has an extremely low correlation to the country's stock market performance, suggesting more cautious allocation to China.
