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China and the Emerging Markets Investing Mega-Trend

Economics / China Economy Apr 18, 2010 - 12:42 AM GMT

By: Nadeem_Walayat

Economics

Diamond Rated - Best Financial Markets Analysis ArticleThe following is an excerpt form the Inflation Mega-Trend Ebook Page 54-57 (FREE Download) on investing in the emerging markets mega-trend. The ebook includes additional analysis of other emerging markets including, Brazil, India and Russia.


All investors need to have portfolio exposure to emerging markets because that is where most of the new economic growth is going to come from over the next 10 years at least. Whilst the western economies may experience average growth of between 2% to 3%, the emerging markets are expected to experience growth of between 5% to 7%, compound that figure annually and one gets an even better picture of the wide gap in the growth prospects.

Whilst many analysts worry about over heating developing economies and growing bubbles, although forgetting that there is a fundamental shift taking place in terms of risk, as illustrated by the general high indebtedness of western economies over many developing economies, which therefore implies that instead of carrying a risk premium to the west, it is the western markets that should be carrying a risk premium in the pricing of assets.

Furthermore as long as the economies retain the following characteristics then over the long run the risk of losses or underperformance is further reduced. Some of the key characterises that I look for are:

  • Political Stability
  • Economically liberal in terms of free market economics
  • Literate population
  • Abundant Natural Resources
  • Environmentally stable
  • Favourable demographics
  • Low debt to GDP ratio
And last but not least is the per capita graph capacity as illustrated by the following graph:

At the present, the mainstream press is busy worrying about the credit bubble in China, however the economic growth to date has barely bridged the huge gap between the emerging market giants and established western economies which implies a huge potential for the gap to narrow as manifested by strong growth in the emerging markets and below trend growth or even economic stagnation by many of the western economies which means that capital investments made today can be expected to return significant real capital growth over the next 10 years on the basis of real GDP growth that typically targets a growth increase of 100%.

Global Warming Impact on Emerging Markets
The most immediate impact of global warming is on agricultural production due to desert expansion and variability of fresh water supplies. This will most likely impact the 2.5+ billion people across China and India where the share of imported food supplies will continue to increase, thus highly inflationary domestically which will undoubtedly be exported abroad in terms of higher costs of production and supply of services.

With the continuing sea level rise spelling even worse disasters for low lying countries such as Bangladesh which will have increasing inflationary consequences due to millions of people becoming climate change refugees.

Demographics
Many analysts are mistakenly fixated on the so called deflation of Japan being replicated especially in the West whilst completely forgetting the fact that what is driving Japanese stagnation is demographics i.e. the large ageing population that is not as apparent to anywhere near the same extent in either the UK or US, as both have active and favourable policies for IMPORTING young and productive populations from abroad. Though this does put an investment time frame limit on the developing economies such as China which will eventually hit their own demographic time bombs similar to that of Japans, where China's working age population is expected to peak by 2020 and then decline as the burden of the elderly grows. But still offer a good 10 to 15 years of strong growth before economic activity can be expected to taper off as a consequence of demographics.

CHINA

The Chinese fast growing economy with consistent annual growth rates of 10% per annum is on course towards becoming the worlds dominant economy over the next 10 - 15 years, with GDP per capita at just $6,000, China's economy retains the capacity to keep doubling in size several more times before growth rates seriously start to diminish, therefore despite the growth to date the economy still has a long way to go towards even reaching half the per capita income of that of the western economies.

The financial crisis had afforded investors with a great once in a life time buying opportunity to buy into China's growth story at less than SSEC 2000. Maybe we will get some more chances over the coming year though probably nowhere near the depths of what we saw during 2009, therefore the best strategy is to scale into China over a period of time as I mentioned as part of my bear market accumulation strategy way back in October 2008 (Stocks Bear Market Long-term Investing Strategy).

With over $2.4 trillion of reserves and growing by some $400 billion per year, little debt and a very high savings rate of over 30%, China can afford to keep going on highly expansive inflationary stimulus spending sprees so as to buffer its economy from any future economic and financial crisis, whilst in the west each new stimulus will be financed by ever more debt that will have to serviced by means of interest payments in large part PAID to CHINA.

Chinas first growth phase was led by export growth that is gradually feeding into domestic consumption growth which in turn is being followed by the financial growth phase. Which means as long as China does not make the same mistakes as western economies by putting a debt noose around their necks then China remains the investment destination.

The ultimate impact of the Chinese economic super power is that the world will increasingly turn Chinese, as more wealthy Chinese travel abroad so will tens of millions of wealthy Chinese choose to become expats living abroad, especially in the western english speaking world which will likely promote greater economic ties and economic dominance of China across the world as a new economic empire is born, therefore make room for the next big wave of human migration from east to west that will seek to buy up large tracts of the remaining means of production and probably be invited in by desperate government's eager for foreign investment to spark life into stagnating regions.

China Government Competent
Whilst no one in the west would want to live under a totalitarian one party state. However the Chinese government has shown itself to be fairly competent in managing the economy, far better than many western democratic government's which continues to surprise many people that look to the experience of the last communist giant, the Soviet Union which collapsed into hyperinflation. It could be said that being a totalitarian state enables decisions to be implemented far more quickly and similarly any mistakes made can be far more easily brushed under the carpet.

Whilst the western government's have been engaged in piling debt upon debt for consumption, the Chinese have been busy utilising hundreds of billions of dollars of stimulus spending to build up China's infrastructure by building new cities, roads and railways, all of which generates capacity for future economic growth.

China Blowing Bubbles
Yes strong economic growth and high liquidity i.e. bank lending is leading to bubbles that will burst, but the Chinese fiscal position is such that the government can keep blowing bubbles as long as it continues to import foreign currency reserves that can be utilised to cushion the blows which therefore means that the post bubble crashes remain long-term buying opportunities, as the crash of the Chinese stock market to SSEC 1,600 in October 2008 proved.

China to Export Inflation Abroad
China's fast growing and overheating economy is inevitably going to experience significant price inflation. However at the moment China actively intervenes to keep its currency pegged to the U.S. Dollar, that has contributed to an enormous trade imbalance with the U.S. resulting in huge currency reserves that are a natural boost to the Chinese currency were it not for the high level of currency market intervention.

As the inflation mega-trend unfolds and inflation rises in China, then China can with ease let the Yuan appreciate against the other debt ridden currencies over time which has the effect of exporting inflation abroad as the costs of imports into China falls. This will increasingly become the case as the size of the domestic consumer sector grows over the coming years which will feed higher inflation in western economies.

An appreciating Yuan will have the effect of boosting profits for foreign investors when converted back into their own depreciating currencies.

China to Drive Foreign Stock Markets Higher
China is drowning in a sea of dollars that it cannot sell as that would undermine its dollar currency peg objective. However China can achieve the same thing whilst at the same time reducing its risk to a depreciating dollar by investing in dollar assets such as stocks, ETF's and commodities. Therefore those that continue to seek a bear market in U.S. and other western stock markets fail to recognise the huge potential pool of investment funds that are expected to continue to flow into western and other emerging market stock markets over the coming decade and hence contributing towards driving the stocks stealth bull markets higher.

Though it is not necessary to know which stocks China is buying as it is obvious that a resources hungry China is clearly targeting the resources, and energy sectors, where stock buying would tend to lift the whole sector. China will also be seeking to invest in the large liquid stocks and ETF's with strong cash-flows and profit potentials which the stocks investment section seeks to illustrate.

China Intellectual Growth Problems
One possible fly in the ointment is future political stability, as so far the 'communist' in all but name one party state in China has been able to keep its peoples eyes focused on economic prosperity and not to stray into political activism, whether at some point in time a crunch point comes when a more wealthy educated people demand more openness and freedom of expression.

Another problem that follows on from the authoritarian government structure is that China's access to the information age is very limited, i.e. web searches are usually blocked and user access to the internet closely monitored. This implies that China is unlikely to replicate the global growth in the production of consumer durable goods on to the internet technologies, which will still largely remain something in the hands of the democratic relatively free English speaking world as long as they do not erode their own countries freedoms by means of the states misapplication of technology to prevent free thought.

Chinese 10 Year Stock Market Outlook
A sustained average growth rate for the Chinese economy over the next 10 years of 8% per annum implies a GDP compound advance of 115%. China's Price / Earnings ratio currently stands at approx 30, which whilst still high is down from the eye watering days of the bull market peak that had the P/E as high as 70. Still 30 is NOT cheap and therefore despite the high growth potential of the Chinese economy, this is expected to narrow over the coming decade towards an average of 18.

Therefore taking a P/E of 18, and GDP advance of 115% and applying this to the current SSEC level of 2990, this would therefore suggest a fair value for the Chinese Stock market of approx SSEC 9,200 in 10 years time. Off course the actual trend is expected to function as a consequence of speculative runs to over valuation and subsequent corrections into states of under valuation as we saw with the 2007 peak of 6,250, a stock market boom into a bubble in 10 years time could see the SSEC as high as 17,000 against the current price of 2,990.

Chinese Stock Market 2010

The Chinese stock market has doubled after the powerful rally off of the October 2008 low of 1664 to a high of 3,478. Subsequent price action clearly indicated a period of consolidation is underway with the last close at 2990, the price pattern being painted is that of an ABC correction of which we have just embarked upon a C wave decline that implies the SSEC is currently targeting a correction towards a range of 2750 to 2600 which in my opinion would present a further good long-term accumulation opportunity. As for the end 2010 target ? I expect the SSEC to target an end 2010 level of 3,750 as illustrated by the below graph.

Chart courtesy of StockCharts.com

In conclusion the more I analyse China the more it comes back to me as a screaming long-term buy, China remains one of my KEY investment destinations with an over-weight rating as by far the single greatest source for future world economic growth will be from China. Not only is the country swimming in cash but foreign investors will be ever eager to plow more of their own money into China. So I am firmly putting my money where my mouth is by remaining fully invested in China. Therefore I will let others worry about the potential black swans and stay scared of investing in China.

China Stocks Crash ?
2008 and 2009 have shown us that the markets are extremely volatile, so yes the speculative Chinese stock market could crash, but as long as the fundamentals remain in place i.e. that the Chinese economy continues to grow strongly as it did throughout the recession then market crashes are excellent long-term buying opportunities. Think of it this way, instead of buying the market at 30X earnings a 33% stocks crash offers you the opportunity to buy the same market at X20 earnings. Just as the crash to below SSEC 2k presented a golden opportunity to buy China in 2008.

Foreign Investors Currency Advantage
Foreign investors should also take note of the strong currency advantage of investing in China, as the Yuan will eventually appreciate against all fiat currencies. This means that over 10 years investors in say sterling could see their returns increase by as much as a further 50%, as the current trade imbalances are not sustainable, i.e. last year China exported $338 billion to the U.S. whilst importing $69 billion, which should have resulted in a significant Yuan appreciation, but the exchange rate has not budged for the past 18 months which strongly suggests intense currency market intervention to hold the peg to the dollar that will culminate in a series of rapid revaluations, thus driving the value of Chinese investments higher in currencies such as sterling and the dollar. Therefore foreign investors into China are effectively buying an inflation hedge on top of capital growth as a consequence of economic growth.

China ETF's
There are several liquid China ETF's available including iShares China Index Fund (XCH), iShares FTSE/Xinhua China 25 (FXI) and SPDR S&P China ETF (GXC) as a starting point for your own research.

Download the full 100 page Inflation Mega-Trend Ebook for FREE (only requirement a valid email address) which includes precise forecasts trends for major markets for many years :

  • Interest Rates
  • Economy
  • Inflation
  • Gold & Silver
  • Emerging Markets
  • Stock Markets
  • Stock Market Sectors and Stocks, including ETF's
  • Natural Gas
  • Agricultural Commodities
  • House Prices
  • Currencies
  • Crude Oil

Source: http://www.marketoracle.co.uk/Article18738.html

By Nadeem Walayat

http://www.marketoracle.co.uk

Copyright © 2005-10 Marketoracle.co.uk (Market Oracle Ltd). All rights reserved.

Nadeem Walayat has over 20 years experience of trading derivatives, portfolio management and analysing the financial markets, including one of few who both anticipated and Beat the 1987 Crash. Nadeem's forward looking analysis specialises on UK inflation, economy, interest rates and the housing market and he is the author of the NEW Inflation Mega-Trend ebook that can be downloaded for Free. Nadeem is the Editor of The Market Oracle, a FREE Daily Financial Markets Analysis & Forecasting online publication. We present in-depth analysis from over 500 experienced analysts on a range of views of the probable direction of the financial markets. Thus enabling our readers to arrive at an informed opinion on future market direction. http://www.marketoracle.co.uk

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any trading losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors before engaging in any trading activities.

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© 2005-2018 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Comments


18 Apr 10, 16:01
Inflation mega trend

Great piece !


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