It can be a challenge to capture the many facets of a country with historical records reaching back into the realm of legend (5,000 years ago) and one that houses nearly 20% of the world's population. China is constantly in the media on wide-ranging issues. Typically our articles focus mainly on the risk and return of investing in a country; however, we also wanted to bring into focus some of the broader trends in the country.
Even though it is not considered a "developed market," there is tremendous attention focused on China today. Developed markets (e.g. U.S., Germany, and France) are generally those with sustainable economic development, sufficient liquidity, and high market accessibility (open to foreign investment). China is not considered a developed market as it is in the process of opening its borders by using political and economic reform. It is still a Communist nation, with the government maintaining tight control over the people's lives, but it has begun promoting private ownership, international investment, and entrepreneurial ventures.
Given the sheer size of China, it is hard to ignore. It is the largest component (19.6%) of the MSCI Emerging Markets Index. As of 9/30/2013, performance of China's stock market in 2013 (+0.2%) and over the past 10 years (+15.5%) has been better than the aggregate emerging markets (-4.4% and +12.8%, respectively). When compared to developed markets, China's return is significantly behind for 2013, as concerns about their slowing economic growth and other factors have resulted in weaker relative performance.
GROWTH UNDER THE MICROSCOPE
It is true that China's economy is slowing down, but it is also showing signs of stabilization, helped by government policy support and improvement in global demand. Most economists believe China's GDP growth rate will slow to a pace between 7.0% and 7.5% for 2013 - a robust growth rate but a significant reduction from the 10%+ growth rates it has enjoyed in recent years.
The government has said it is willing to tolerate slower growth as it pushes reforms designed to reduce pollution, social inequity, and an over-reliance on debt-financed construction and exports. So far, it has avoided massive stimulus policies but has used "mini-stimulus" policies, such as speeding up subway/rail projects, offering tax breaks, and cutting red tape to help boost growth. The country's economic health matters because it buys so many commodities from both emerging and developed markets worldwide, and it is the world's largest exporter.
CHINA'S ERA OF REFORM
For a country with such a long history, China has come a long way in the past 30 or so years! In 1978, China had a planned economic system, a predominantly poor and rural population, and a society wracked by 10 years of Mao's Cultural Revolution. China has made huge yet gradual changes since then, a few of which we capture below.
Reforms began in the countryside in the 1980s, and farms were converted from government-run production teams to family farming.
Gradual Opening of the Global Economy
The government established four Special Economic Zones (SEZs) in 1979 offering preferential policies for foreign investors, such as lower tax rates, streamlined approval processes, and exemptions from foreign exchange regulations among other benefits. These grew to nearly 7,000 development zones by 2004 as nearly every jurisdiction competed for global and domestic capital. In addition, China joined the World Trade Organization (WTO) in 2001.
Growth of Private Enterprise
China has been introducing drastic reforms to reduce the state sector of the economy. Although private businesses still face political constraints and have limited access to financing and credit, private business owners have made significant headway.
By 2010, China surpassed Japan as the world's second largest economy. Even more surprisingly, the Chinese Communist Party presided over dynamic economic growth while avoiding the kind of political collapse experienced in other Communist nations such as Russia and in Eastern and Central Europe. China's large population is its greatest opportunity with over 1 billion consumers, many becoming accustomed to a higher standard of living than in past generations.
A WORK IN PROGRESS
As with any situation, there are always challenges to work through.
China is still viewed as "The World's Factory."
China's population size and emphasis on manufacturing contribute to a rate of natural resource consumption and air and water pollution that many consider unsustainable.
This is an ongoing perception and reality in China. Even China's own party leaders admit corruption is the biggest threat to the leadership's legitimacy.
China's economic miracle produced various inequalities, such as the gaps between urban and rural Chinese and between coastal and inland areas.
Real Estate and Banking System Worries
Residential and commercial real estate construction has boomed in recent years causing concerns over excessive bank lending and overbuilding.
Despite the complexities and "hand-wringing" surrounding China's current slowdown, we maintain broad diversified exposure to the country as it is a large part of the emerging world. While volatility will generally always be higher in these markets, we believe China is a good long-term investment as part of a diversified global portfolio, which includes allocations to over 60 countries including developed, emerging, and frontier markets.
Sources: Harvard Business School, "The "Chongqing Model" and the Future of China" paper, Vanguard, MSCI, FEG, Morningstar Direct, Dow Jones
The most populous country in the world is gradually undergoing major reforms and cannot be ignored.
It is home to some of the world's largest companies and has experienced faster economic growth than much of the world.
China's return has outpaced other emerging market countries in 2013, but concerns about slowing economic growth have caused it to lag developed markets.
Although it has tremendous positive trends, it is still an "emerging" market and has a ways to go before becoming a "developed" market.
This article is an excerpt from the SAVANTalk 3Q2013 newsletter created by Savant Capital Management.