Do you know the ‘China’ story?

Hello monkeys – Over the last three years, I have observed an enormous increase in the attention paid, both by sell-side and buy-side, to developments in China. One post does not do justice to the topic but hopefully this can get you started in forming a macro view on China:

On April 20th, 2014, Forbes carried an article suggesting that Li Ka-Shing, the 'Superman' of Hong Kong and 'China's Warren Buffet', is moving out of China which may indicate an early warning of an imminent slowdown. Meanwhile, the real Warren Buffet has, very famously, said:

The 19th century belonged to England, the 20th century belonged to the U.S., and the 21st century belongs to China. Invest accordingly

So what of China? The investment community can be split into two diametrically opposite camps on the future of China. The bulls argue that China is on the cusp of breaking out as the world's biggest superpower, as it had been for centuries before the Opium War. They point to long term bullish factors such as urbanization and a surge in consumer demand over the next few decades. The bears point to dangers of excessive corporate debt, inefficient State Owned Enterprises and long term structural declines from an ageing population. China's 'Hard Landing' is a popular topic in the latter camp.

At the heart of the issue lies interest rates and financial repression. Ever since Deng Xiaoping led China through a thirty year economic boom that brought the country to the global centre stage, interest rates have been artificially suppressed to promote the manufacturing/export sector and the banks at the expense of the household sector/ordinary citizens. Cheap labour costs and the PBOC's massive purchase of incoming US$ to maintain a competitive exchange rate, helped China to emerge, until 2008, as a champion exporter of everything from toys to electronic devices. This export machine fueled the country's GDP but GDP growth, in itself, became a target for the Party. With global demand for China’s exports contracting as a result of the 2008 credit crisis, the shortfall in China’s GDP growth target was compensated by investment (or over-investment as the bears would call it) in infrastructure and property. Repressed interest rates and volatile stock markets also meant that households had few avenues to deploy their meagre savings apart from real estate. This collective zeal led to some ghost cities, which spooked the western media leading to your customary bearish FT and WSJ articles on the upcoming 'China Hard Landing'.

Indeed, the famous hard landing never arrived but real GDP growth has slowed down materially from 10%yoy+ pre crisis to 7.4%yoy in 2014. So the absence of 'hard landing' has not entirely vindicated the bulls. The other 'success' that bears point to is the dismal long term performance of China's stock markets (atleast until the last four months) - both A shares and H shares, when compared with the country's GDP. This leads some extreme bears to declare that China's GDP growth is a man-made fiction - a view that Wikileaks claims has been corroborated by the country's current premier back in 2007. The bulls argue that China's stock markets are massively undervalued and offer the most significant investment returns as P/E ratios rerate, when the bearish sentiment inevitably subsides (as it seems to have following the launch of Shanghai-Hong Kong stock-connect).

China Property remains at the centre of this debate. The recent slowdown in property prices, collapse in national sales and property investments and the hurried relaxation of Housing Purchase Restrictions (HPRs) in a slew of cities, together with the easing (both fiscal and monetary) carried out by regulators, suggests that the debate may be close to an inflection point within the next couple of years.

Take your pick on which side you will put your money: Chinese stocks are up more than 40% in the last four months. Irrespective of the eventual outcome, China will likely represent the most significant case study in economic planning for business students in the twenty-first century.