Investment Strategies

Evercore Comment: Bear In A China Shop?

John Redwood Evercore Chairman investment committee London 22 February 2012

Evercore Comment: Bear In A China Shop?

Those who worry about China and the risks of a hard landing are ignoring some inconvenient evidence that suggests China's economic prowess is based on strong fundamentals, argues Evercore.

The following investment and market commentary comes from John Redwood, chairman of Evercore Pan-Asset's Investment committee. Besides his work in the financial sector, Redwood is also a Conservative member of the UK parliament and a former government minister and policy advisor. 

I have been urging investment in China for the last few months. So far, it has been going well. Last autumn the Chinese market looked very cheap. It was selling on 8 times earnings and offering nearly a 4 per cent yield. The background was persistent bearishness by most professional western commentators.

Today there are still plenty of bears in the China shop. I have just read a piece claiming that China’s low public sector debt ratio of around 20 per cent is really over 100 per cent, if you add in pension liabilities, possible local government losses, and possible banking losses. The commentator did not say what such draconian accounting treatment would do to the much larger western sovereign debt levels already recorded.

Many bears claim that there will be a big housing bust in China. They concede that it will not come about as it has in the US, UK and Spain from excess mortgage credit, as many Chinese buy their properties with cash. Chinese buyers needing mortgages have on average relatively low debt to price ratios. They just think sentiment is now negative and this could turn into a crash. If property goes, so then the banks get into trouble. China, they argue, could do what much of the west did in 2008. It is true recently house prices have been falling a little. They could fall more. Banks could have larger losses. I suspect the Chinese state will act to stop this doing serious damage to the wider economy.

I think the persistence of this thinking can be turned round to be part of the bull case. Western smart commentary has kept most funds out of China altogether, or has limited them to very small investment positions in the world’s fastest growing large economy. There are not many westerners around with shares to sell. There are many more pondering whether they should, at some stage, put some money in, or increase the size of their stakes.

Last Thursday I was on a panel at a conference organized by Quantum Advisory, talking to pension trustees. I was one of a panel of three. My two expert and articulate co-panelists put the case for share investment in Europe and in the US respectively. They did so well, illustrating their arguments with charts and graphs seeking to show the good value in their chosen markets. I was asked to make the case for China. I did so in general terms, and reminded my audience of its poor performance last year and the risks people saw in it. The other two argued strongly there is no correlation between stock market performance and rates of growth of an economy. They reminded the audience of the very different government and economic system in China. At the end of our exchanges our host asked the audience which of the three markets we had discussed would receive their money, if they each were given £10,000 ($15,805) for their own personal investment and had to invest in one of the three. Five hands went up for Europe, two hands went up for the US and the large majority voted for China. That decision clearly reflected their views and the facts of the case.

Last year the Chinese economy grew by 9%. Industrial profits were up by 25 per cent. 12.2 million new jobs were created in the cities, where unemployment averages 4.1 per cent. The economy is running a substantial trade surplus, official government borrowings are light and the overall tax rate is just 22 per cent. The budget deficit is under 2 per cent of GDP. Some 38 per cent of the workforce is still employed in agriculture, producing just 10 per cent of total economic output. This leaves plenty of scope for more people to come off the land into more productive employment.

In 2011 China started her new 5 Year Plan. At its heart is the wish to boost incomes, living standards and domestic demand. China is well aware of the limits to more growth from exporting to heavily indebted western societies. There may be no correlation in any given year between economic growth and stock market performance. There clearly wasn’t last year. However, when you have a year like 2011 when the Chinese Stock market went down and profits and output went up, it is not too simple to say that all things being equal shares just got a lot cheaper.

All those people who worry about China should ask themselves why has the market started to rise so well? Could it just be that China’s obvious achievement in making, exporting and investing will from time to time come out in higher share values? What more do the bears want China to achieve?


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