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Forget The News: If You’re Not Exposed to China, You Should Be. Find Out Why.


  • Don’t be scared by the news, China is growing strong and has incredible future prospects.
  • Temporary bumps are and will continue to be normal.
  • Portfolio diversification with China is essential for increased returns in the future.

Introduction 

Exactly a year ago fears around slower economic growth in China, the Yuan devaluation, and oil prices below $40 were the main catalyst for a market correction. The S&P 500 fell from 2102 points on August 17, 2015 to 1867 points on August 25, 2015.

In today’s article we are going to analyze the current situation to see if things are better, or if the market has shifted its focus to other things.

Yuan, Economic Growth and Oil

When the Chinese government devalued the Yuan it spread fears around the globe that the Chinese economy might be doing worse than previously assumed. Everyone knew China was slowing down, but expected growth was still at 7%.

The Chinese government devalued its currency by 3.2% on August 15, 2015. Since then the Yuan has further depreciated by 3.5% against the dollar, but no one seems to care about that anymore.

figure 1 usd yuan
Figure 1: Yuan per 1 $US. Source: XE, author’s own annotations.

The fear then was that Chinese economic growth was going to slow down more than expected. And while growth has been slightly less than 7% over the last year, it is still growing at 6.7%.

figure 2 chinese growth
Figure 2: Chinese annual economic growth. Source: Trading Economics.

In order to avoid a hard landing, the Chinese government has taken action. It has forced state-owned companies to increase investments, and it further lowered interest rates to a record low of 4.35% which further increased debt, forcing the debt to GDP ratio to record highs. In its annual review of the Chinese economy, the IMF (International Monetary Fund) stated that policy actions improved the Chinese near term growth outlook but “the medium-term outlook, however, is more uncertain due to rapidly rising credit, structural excess capacity, and the increasingly large, opaque, and interconnected financial sector.”

Increasing debt to GDP means that China is using debt to keep its growth stable which isn’t unusual, but does tell us that without increased debt levels the economy would have slowed down sharply. Current Chinese debt to GDP is 43.9% which is still very little when compared to the U.S. with 104.17%, especially when we know that China is growing at a 6.7% rate and the U.S. at a rate of 1.1%.

figure 3 debt to gdp
Figure 3: Chinese debt to GDP. Source: Trading Economics.

Even the IMF, in its closing remarks, states that Chinese debt is not worrying, especially as China is transitioning from a manufacturing economy to a service based economy which is never a smooth transition.

The final scare last August was that oil prices fell below $40. At the moment oil prices are again around $40, but the S&P 500 is still stable at above 2150 points as this is considered the “new normal.”

figure 4 oil price
Figure 4: Oil prices. Source: Bloomberg.

Local Perspective

In order to better understand what is going on in China, it is a good idea to take a local view which will provide us with a better understanding of the headlines we have read or may read in the future.

Regional data for the first six months of 2016 show that economic growth increased in 15 of the 31 Chinese provinces which indicates that things are, if not turning around, pretty stable in China. On the other hand, difficulties in the coal industry have created a recession in the provinces based on coal and steel production.

figure 5 province growth
Figure 5: Chinese economic growth by province in 1H 2016. Source: Bloomberg.

The chart above is essential for understanding that China is transitioning and therefore economic problems have to be expected, but at the same time, China is still booming. Don’t let negative news about a specific sector or province in China scare you about its future prospects. A longer term perspective will give us a better view of where China is now and where it is headed.

Longer Term Perspective

The GDP per capita indicator is the best way to see where a country is and where it is going. The current GDP per capita in China is $6,416 which is just 12% of the U.S. level ($51,486).

figure 6 gdp per capita
Figure 6: Chinese GDP per capita. Source: Trading Economics.

The low starting level is reassuring for the future as there is still plenty of room to grow. Fears about China should be cast aside when looking at the longer term perspective, and not be reacted to like they were last August as the IMF still predicts that China will grow around 6% for the foreseeable future.

figure 7 gdp forecast
Figure 7: IMF Chinese growth prediction. Source: Knoema.

Conclusion

All in all, we can say that China is doing well and that last year’s August scare was just that, a scare, and a market misperception. China is a large country that still has plenty of room to grow. It is completely normal for it to be a bumpy ride, and seeing what China has done in the past 25 years gives confidence that the country will continue on its growth path, and scary moments can be used to buy investments on the cheap.

Given the positive long term prospects, it might be a good idea, if you haven’t already, to have your portfolio exposed to China. This can be done by buying Chinese ETFs or being overweight in companies that have a large exposure to China. The iShares China Large Cap ETF’s (NYSE: FXI) historical performance shows how investment performance is related to economic growth.

figure 8 etf - new
Figure 8: $10,000 invested in the China large cap ETF in October 2004. Source: iShares.

Therefore, with much weaker prospects in the U.S., don’t let frightening headlines scare you. Diversify into China, there is still plenty of room to grow.

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