- July 2, 2012
- Unmasking the Asian Giant
Chinese operas have been keeping audiences enthralled for hundreds of years with mythical characters, enchanting stories and elaborate masks that add drama and mystery. While this fantastical treatment is appreciated in the theatre, it isn’t in global markets. Investors don’t like mystery—think of how uncertainty has spooked markets in recent years.Global investors are rarely privy to every detail about the economy; that’s why it’s necessary to rely on multiple data and research to make decisions and be cautious of extreme views that unnecessarily arouse suspicion, skepticism, and criticism. These opinions may grab headlines, but rarely do they help investors’ portfolios.
A recent article in The New York Times raised doubts about the quality in China’s macroeconomic reporting. The Times pointed to evidence from “prominent corporate executives in China and Western economists” who say that “local and provincial officials are falsifying economic statistics to disguise the true depth of the troubles.” The author alarmed many of our readers, so we immediately contacted numerous analysts—many of whom have front row seats to Chinese economic data—to get their reaction.
Some analysts preempted our request by independently sending out a rebuttal, including CLSA’s China Macro Strategist Andy Rothman, in his Sinology report titled, “Lies, Damned Lies…” Since 2006, global investors have come to rely on this company’s coverage of China because of its ability to “independently monitor mainland economic activity.” See Andy’s insightful views on China from a recent webcast.
Don Straszheim from ISI also emailed his view on the veracity of Chinese data. (We note that Don was correct on a recent call on China. When he visited our office at the beginning of June, he correctly predicted the interest rate cut, which China made two days after his visit.)
We’re all influenced by emotions, of course, and when used to our advantage, can help guide how we invest. However, we need to be aware of how outside biases can influence our judgment. In Thinking, Fast and Slow, Daniel Kahneman writes about a mechanism through which biases flow called an “availability cascade,” a term coined by Cass Sunstein and Timur Kuran. Kahneman says the availability cascade is a “self-sustaining chain of events, which may start from media reports of a relatively minor event and lead up to public panic and large-scale government action.” The vicious cycle goes like this: As people begin to worry, they seek more information and are attracted to similar news reports, which encourages additional coverage. The “availability entrepreneurs” are the ones who deliberately want to keep the negative news flowing.
This may not have been the intention of the Times—and other China bears—but its business is selling newspapers.
Kahneman focuses his discussion on how policies should take into consideration a combination of “experts’ knowledge with the public’s emotions and intuitions.” This thinking also relates to investment decisions, which is why our SWOT model is designed to help us review a variety of sources, along with emotion and intuition, and categorize the results in terms of strengths, weaknesses, opportunities and threats.
We encourage our readers to take this approach: Read the Times article and analyze it alongside what analysts are saying:
It’s not breaking news that China’s data is less-than-perfect. Analysts have been saying this for years. CEBM says simply that the Times article is “a true but not new story,” while ISI believes “the shortcomings of China data is a topic every China macro journalist writes on every year or so—with small variations and supporting anecdotes.”
Part of the reason the topic of China’s “disguise” keeps coming up stems from the fact that the country has not had a very long history of “professional independence from the political machinery in Beijing,” says ISI. Unlike developed countries, ISI believes China’s data system continues to be opaque and primitive. The countries’ inadequacies are relatively common among emerging markets, as numerous analysts have pointed out.
This fact does not release China from its responsibility to make sure that investors have accurate information. Rather, because the country has become an economic powerhouse, it is under greater scrutiny, which means it needs to improve its checks and balances. CLSA says the central government has been aware of how local officials inflate their data and “has been taking steps to mitigate the problem.” For example, more than 700,000 companies now report their data directly to the National Bureau of Statistics, rather than the local governments. NBS data is typically used to forecast consumption of key commodities, says CLSA.
The Times discussed how electricity production and consumption is “a telltale sign of a wide variety of economic activity” and is a “gold standard” for finding out how the economy is doing. A few months ago, U.S. Global’s analyst, Xian Liang talked about how important electricity consumption was as a measure of activity—some commercial banks that lend to small companies would physically check the meters themselves.
As shown in the chart below, over the last few years, China has reported electricity consumption that was much more volatile than real GDP data. Noting the extreme at the end of 2008, it’s likely that GDP fell more than was reported, and at the end of 2009, GDP likely rose more than publicly reported, says ISI.
However, the logic of the Times article to think that local officials are “overstating” data seems misguided. According to Bank of America-Merrill Lynch, China’s local officials have little incentive to over-report the use of energy because “Beijing imposes increasingly restrictive regulations on energy use per unit of GDP on local governments.” Also, since 2011, many local officials have been trying to encourage the government to ease tightening measures, so it is not in their interest to over-report power data to mask a slowdown.
What’s needed before investing in any emerging market is an ability to decipher the mountain of data and use informed judgment. Because “all data in China are not created equal,” ISI bases its opinion on data, giving more credibility to data that is independent and discounts data that is confusing or biased. Data including purchasing managers’ index, export and import volumes, auto and vehicle sales and production, transportation and People’s Bank of China are generally high-quality and credible, says ISI.
There’s no denying the importance of China. Take a look at McKinsey’s map showing the rapid shift in the world’s economic center of gravity. Beginning in AD 1, for nearly 2,000 years, the economic center of gravity was in Asia because population growth and migration were slow. Industrialization and urbanization in Europe and the U.S. quickly shifted the economic power west for the next century. Now, “China is urbanizing on 100 times the scale of Britain in the 18th century and at more than ten times the speed,” says McKinsey.
In fact, in the past three years, a combination of lower growth in the developed countries, combined with the fast urbanization of the emerging world, the economic power has reverted back toward the east at the “fastest rate of change” in history.
Here’s another way to visualize China’s reversion to the mean, which we showed a few days ago:
All the World’s Not a Stage
China is far from perfect: While actors can perfect their lines and use masks to captivate an audience, smart investors know better to use a wealth of information across numerous sources to guide investment decisions. Weigh the evidence and judge for yourself. As my friend, Investment Strategist Keith Fitz-Gerald said in an interview, “A powerful China is coming, and we have two choices. Either we’re at the table, or we’re on the menu.” To him this means, “Good news from China is good news for the U.S.; bad news from the Chinese economy is bad news here.”All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. The PMI Composite Index is based on the seasonally adjusted diffusion indexes for five of the indicators (New Orders represents 30%, Production represents 25%, Employment represents 20%, Supplier Deliveries represents 15%, and Inventories represents 10%) by the varying weights.
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- June 20, 2012
- Rising China is a Misnomer...and Other Actionable Takeaways
Did you know that at the beginning of the 19th century, China made up the largest share of the world’s GDP? This makes the term “Rising China” a misnomer, as the country has been simply returning to, instead of rising to, super power, says former U.S. Secretary of State Henry Kissinger.
This is only a fraction of what U.S. Global’s analyst, Xian Liang, learned at the J.P. Morgan China Conference in Beijing. About 2,000 investment professionals from 30 countries were in attendance hearing from well-known speakers around the world. The show went on without Jamie Dimon, who was testifying before the Senate about the recent $2-4 billion trading loss. It’s interesting that this is the first time in 79 years for a bank executive from J.P. Morgan to testify; the last time was when Jack Morgan testified before the Senate in 1933.
Here are other takeaways we thought you’d find interesting:
- Record-Breaking Growth Pace. Global Head of Equities Carlos Hernandez from J.P. Morgan quoted Robin Meredith, stating that it took England 48 years to double its GDP starting in 1780. In the U.S., it took 47 years from 1839. In Japan, it took 34 years from 1865; South Korea only took a remarkable 11 years from 1966. China set a record, doubling its GDP in only 9 years from 1978, and again from 1996.
Significant Trading Partners. U.S. Ambassador to China Gary Locke says in 1972, annual bilateral trade between the U.S. and China was less than $100 million (back then, the largest category of U.S. exports to China was cereal; from China to the U.S. it was animal parts). Now trade is more than $1 billion a day, with 800,000 U.S. jobs dependent on exports of goods and services to China. - Improved Trade Relations. Former U.S. Secretary of State Henry Kissinger says U.S relations with China have come a long way. As one example, back in the summer of 1969, it took a month of debates between the U.S. administration and Congress to agree to allow American citizens to buy up to $100 worth of Chinese goods through Hong Kong.
- Rising Tourism Potential. Chinese tourists spend on average $6,000 per visit to the U.S. (This compares to an average of $4,000 spent for all tourists, as I indicated in a recent post.) Since he took over, Ambassador Locke has cut the average waiting period for visitor visa interviews from as long as 100 days several years ago to less than six days.
- Strong Leadership. China’s biggest positive is that the country has strong leadership, as opposed to a leadership vacuum in Europe whose monetary policy is hijacked by fiscal policy, which is, in turn, hijacked by the social welfare system, says China Investment Corp. (CIC) Chairman Jin Liqun. In other words, the European crisis is not an economic predicament, but a political one fraught with errors in macroeconomic policymaking and implementation.
- Evolution vs. Revolution. Former Prime Minister of the United Kingdom Tony Blair said his recent tour to the Middle East left him with the impression that in the short term, regional sentiment for “revolution” may continue, but over the longer term, government policies are needed to facilitate “evolution.”
- Numbers of Parties Matter. CIC Vice Chairman Gao Xiqing is quite constructive on the U.S. Despite the “fiscal cliff” fears, it’s still easier to manage two parties (in the U.S.) than 76 parties (in Europe).
- Huge E-Commerce Growth. Several speakers, including Expedia’s Chairman Barry Diller, Newmont’s CEO Richard O’Brien, and Pepsi’s Chairman for Greater China Tim Minges, see e-commerce as one of the most exciting opportunities to invest in China. E-commerce has been taking share from traditional retail and now accounts for 4 percent of retail sales.
- Ideal Conditions for E-Commerce. The last mile of infrastructure is now complete (speedy intercity delivery), and China has all the right conditions for e-commerce to thrive: 1) smart, thrifty shoppers who will buy the same product online if cheaper, 2) pervasive distrust, which boosts a firm such as Alipay (subsidiary of Alibaba) that allows customers to pay only after product is delivered and satisfaction confirmed, and 3) low cost, speedy delivery (only a half to one-third of what is considered standard shipping time in the U.S.). Around 40 percent of Chinese internet users shop online.
The last two points affirm Xian’s belief that there is considerable potential to monetize the Internet in China. He shared the following charts with Investor Alert readers: In 2010, Chinese spent about half of their time on the Internet, significantly more than people in Japan, Korea, the U.S. and the U.K. Meanwhile, online ads spent as a percent of total ads is the lowest in China compared to the other countries.
I’m a big believer in combining tacit and explicit knowledge, and as our investment team circles the globe scoping out investment opportunities, I’ll share more of their insights. In the meantime, feel free to forward these posts to your friends.
All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. The following security mentioned was held by one or more of U.S. Global Investors Funds as of 3/31/12: Newmont Mining Corp.
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- June 11, 2012
- China Eases the Way
Following negative data last week, investors were clearly concerned about global growth and anxiously anticipated government actions. While Europe and the U.S. disappointed investors, China surprised on the upside by cutting interest rates. The market reacted positively, as the S&P 500 Index increased 3.7 percent.
It’s clear the government’s tone in China shifted this week with the rate cuts. The government appeared to be comfortable with slower growth, but that position seemed to change as the country took steps to avert a hard landing and cut interest rates to stabilize the economy.
Over the past decade, there were only two periods when the government reduced rates: once in 2002, and several times at the end of 2008. This time, rates were cut by 25 basis points each on lending and deposits. The one-year benchmark deposit rate is now 3.25 percent and the 1-year lending floor rate is now at 6.31 percent. Historically, easing rates have been positive for the MSCI China Index.
As we often say at U.S. Global Investors, government policy is a precursor to change. While there has been quite a bit of negative news lately, government policy is making a significant step toward growth. We believe now’s not the time to be bearish.
Analysts are only beginning to see signs of increased infrastructure spending, which should help spur growth for the remainder of the year. If you’ll remember in 2011, China deliberately tightened its credit policy to stem inflation and slowed financing to local governments, says J.P. Morgan. As a result, fixed asset investment growth in infrastructure decelerated considerably, and railway investment was completely halted, decreasing nearly 20 percent on a year-over-year basis during the second half of 2011, says J.P. Morgan.
The decline in infrastructure and real estate investment on a year-over-year percentage change is clearly seen in CLSA’s chart, and it’s what Andy Rothman has attributed to slower growth in the world’s second-largest economy:
Highway infrastructure spending “increased sharply” from January through April, particularly in Western China, says J.P. Morgan. The research firm says that the economic growth rates in the Central and Western areas of the country “already outpace those of more developed coastal provinces.” Fixed asset investment for infrastructure, energy development and water projects in the Central and Western regions has grown at a faster clip than in the Eastern region on a year-over-year basis.
Rail infrastructure has also picked up. As of the end of 2011, the Ministry of Railways received a credit line of more than $300 billion from banks, and plans on issuing additional railway bonds, seeking investments by pension funds and encouraging the private sector to invest, says J.P. Morgan.
With fixed asset investment in the rail sector growing 34 percent on a month-over-month basis, this government support is “starting to be translated into action,” says Macquarie Commodities Research. If we see spending in railways continue to increase, China will be able to meet its full-year target, according to Macquarie.
China’s GDP during the second quarter is likely to be about 7.5 percent, and the expectation for 2012 remains at 8 percent. While the country’s GDP is lower than its 2010 high of 12 percent, it is helpful to put this in context with global growth. “Comparatively, it looks like strength—not weakness,” reiterates ISI.
What’s important for investors to realize is that the combination of a ramp up in targeted fiscal spending combined with broad-based monetary easing is a positive dynamic not only for China—but for the global economy as a whole.
John Derrick contributed to this commentary.
The MSCI China Index provides coverage of the large and mid cap segments in the China market. The S&P 500 Stock Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies.
All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.
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- June 4, 2012
- Will the ECB and Fed Follow Where China Leads?
Every month, policymakers track purchasing managers’ indices (PMI) around the world as they consider fiscal and monetary actions. To us, a PMI is a measure of health of companies around the world, because it includes output, new orders, employment and prices across manufacturing, construction, retail and service sectors.
Today, the J.P. Morgan Global PMI for May came in lower at 50.6—just above the level indicating expansion—and China’s HSBC Manufacturing PMI fell to 48.4. Both numbers were below their respective three-month moving averages. Historically, we’ve seen China’s PMI number leading the year-over-year change in exports by three to four months, so when the PMI has increased, a few months later, Chinese exports have historically risen, and vice versa.
China’s HSBC PMI tends to be more reflective of export demand, as it is compiled by private parties, covers a smaller survey sample and is weighted toward smaller businesses. Therefore, a lower PMI number indicates lower export demand.
With Europe’s growth in a deep freeze, China is feeling the pain. While many think the U.S. is receiving most of the Chinese-made goods, Europe is actually China’s largest export partner. Nearly 22 percent of China’s exports head to Europe, contributing nearly 6 percent to China’s GDP; only 17 percent of exports from China are shipped to the U.S.
With fewer exports to Europe, China’s GDP growth could be affected, but probably much less than one might think. Listeners of our webcast a few months ago heard Andy Rothman from CLSA explain how China has become less dependent on the world for its growth. As you can see from the chart below, CLSA had already assumed net exports of goods and services out of China to be negative this year because of slower growth from Europe and the U.S.
Yet, China clearly has the upper hand in controlling growth. Take a look at what happened in 2009 when exports declined dramatically: The government stepped in with a massive stimulus package devoted to bank lending and infrastructure construction. This effort significantly boosted overall GDP growth and “pushed the Chinese economy out of a deep slump,” says research firm BCA Research.
Despite net exports falling about 4 percent in 2009, GDP actually grew more than 12 percent.
China won’t put the pedal to the metal like it did in 2009, though. Premier Wen Jiabao recently said that the government “should continue to implement a proactive fiscal policy and a prudent monetary policy, while giving more priority to maintaining growth,” according to Bloomberg News. China is more like Goldilocks: The government wants the economy to be not-too-hot or not-too-cold.
The important thing to remember is that the government will want to avoid the expansion that was “associated with the earlier plan that led to higher CPI, asset price inflation and a surge in lending to non-priority projects,” says J.P. Morgan. Rather, the focus is on making sure the country shifts to a “more sustainable trajectory of growth,” says the research firm.
With the renewed eurocrisis, “Chinese authorities are currently facing an extremely complex and unpredictable situation,” says BCA. They’ll continue to monitor the situation and not make any drastic moves; rather, “Chinese authorities will stay on high alert and act promptly to rescue growth in case of external shocks,” says BCA.
So what will they be tracking as they monitor the situation? We’ve heard the new Chinese Premier-to-be Li Keqiang is paying attention to three factors: power production, railroad freight volume and new bank loans.
Power production in April was slightly positive on a year-over-year basis, but still remained weak.
On May 31, railroad freight volume was released for April, and showed an increase of 3.3 percent over last year, the same reading as March.
New bank loans are down 7.8 percent year-over-year as of May 11, which we believe was the primary reason that China cut the required reserve ratio (RRR) on May 12. J.P. Morgan agrees, saying that together with the RRR cuts, “the seeming start of a new cycle of public spending and consumer stimulus should help to boost loan demand in the economy.”
Looking at the five year data above, all factors are near their lows and below their 3-month moving averages. In whatever shape or form, we expect policy easing to continue.
What appears to be overlooked by the mountain of negative economic news is the fact that China’s stock market is outperforming. In May, the A shares were the best-performing equities among all the developed and emerging stock markets we track. For the year, China’s investors still hold onto a gain of 7 percent, putting the country among the top half of the emerging markets and above all developed markets. This bifurcation may be signaling that the worst is behind us.
Keep in mind that negative news in the media may be a danger sign to some people; to Chinese policymakers, it’s a signal to act.
We believe the next government policy cycle might be just around the corner. In fact, we’ve already seen indications of stimulus from China, such as giving the “green” light to car buyers. Perhaps the European Central Bank and the Federal Reserve will follow suit to avoid a repeat of the last few summers.
This is only a few of the points I discussed at the Cambridge House’s World Resource Investment Conference in Vancouver. I hope to post my presentation on www.usfunds.com in a few days.
All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.
The Consumer Price Index (CPI) is one of the most widely recognized price measures for tracking the price of a market basket of goods and services purchased by individuals. The weights of components are based on consumer spending patterns. The Purchasing Manager’s Index is an indicator of the economic health of the manufacturing sector. The PMI index is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment. The Shanghai A-Share Stock Price Index is a capitalization-weighted index. The index tracks the daily price performance of all A-shares listed on the Shanghai Stock Exchange that are restricted to local investors and qualified institutional foreign investors.
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- May 25, 2012
- China Gives “Green” Light to Car Buyers
China just made it a little more affordable to buy a car. Last week, the government announced a one-year, RMB 26.5 billion subsidy program devoted to energy-efficient products. About RMB 6 billion will be set aside for fuel-efficient cars, and the remaining incentives focus on LED lighting, high-efficiency motors, and air conditioners, refrigerators, washing machines and water heaters that comply with energy saving standards. The last time China offered subsidies on autos and appliances, in 2009-2010, there was a tremendous increase in year-over-year production. At the peak, auto output jumped 120 percent while the production of appliances rose about 90 percent.
While the total budget for this program is only half of what the government offered in 2009, Morgan Stanley views this move as having a “positive influence on car demand.”
China also lowered gasoline prices lately, providing a “double benefit” for Chinese car buyers.
The subsidies should be welcome in a country that has become quite the car culture. Over the past decade, the auto industry has grown substantially, accelerating from only 2 million vehicles sold in 2000 to an estimated 20 million in 2012. Over the next three years, ISI estimates that another 22 million to 30 million cars will be sold each year.
Deutsche Bank says this government action strikes “a balance between immediate growth needs and long term goals of moving from an export/investment driven economy to a more self-sustaining consumer based economy.”
In Vancouver next month, I’ll be elaborating on the effect these consumer-friendly policies have on global resources at the World Resource Investment Conference. I hope to bring back plenty of investing ideas like this one to share with you.
All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.
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