Conclusion: Anything but conclusive.
Virtual Portfolio Positioning: Long Chinese equities.
On Wednesday, we had the great pleasure of joining well over a hundred distinguished investment professionals at the New York Academy of Sciences for the Bloomberg China Conference. All told, there were 13 unique discussions on various topics ranging from China’s economic outlook to its real estate market to the opportunities/challenges facing China’s growing consumer sector.
Before we share with you the “best of” version of our notes, we just wanted to briefly reflect upon something that struck me us quite odd: with the exception of NYU professor Ann Lee, none of the 28 panelists were: a) from China or b) Chinese-Americans with valuable connections to the mainland. In fact, the vast majority of the seven-plus hours of discussion centered on the opinions and beliefs of American PMs, professors, and policymakers. Not that this is an issue prima facie – as each of presenters was highly accomplished, well-deserving, and thoughtful – but the general lack of Chinese voices on issues pertaining specifically to China is particularly bizarre in our opinion.
That speaks volumes to what we thought were my two greatest learning points from yesterday’s conference:
- While the general tone is grounded in apprehension, there is no discernable consensus on China. In fact, China appears to be a very difficult economy to reach consensus on because so much of what takes place there is just fundamentally misaligned with the patterns we've been trained to recognize through studying other economies; and
- It's clear that U.S. based investors analyze China from a far too Western point of view, imposing potential avenues for reform and structural economic changes that would ultimately serve China to become more like us. But does China want to be more like the U.S.? There was a sense that perhaps the speakers knew all too well what was best for China – perhaps even more so than the Chinese…
Below is a collection of paraphrased notes that we found helpful to expanding the scope of our own internal debates regarding the world’s second-largest economy (sorted by topic of discussion):
- Francisco Blanch: There aren’t enough natural resources or additional scope for productivity gains to keep China growing at +8-10% per annum. The law of large numbers would tend to support this conclusion as well.
- Daniel Rosen: There’s trillions of dollars in low-hanging fruit the Chinese government can spend to support near-to-intermediate term growth: building schools and hospitals, social safety net expansion, etc.
- PROPERTY MARKET
- Axel Merk: High net worth individuals in China own 3.3 residential real estate properties on average. Most go unrented, as maintenance costs dramatically outpace any potential rental yields.
- Michael Shaoul: The utility of real estate in China has changed from “shelter” to “speculation”.
- Sonny Kalsi/Bhaskar Chakravorti: The median home price in China is 20x the median income – more than double the U.S. ratio. That said, however, there is very little in the direction of low-income, commodity housing in China; as such, a great deal of the homes that are being quoted for prices aren’t exactly being marketed to the median consumer. Thus, household affordability isn’t quite as poor as the headline metrics suggest.
- Bhaskar Chakravorti: Commercial real estate – particularly high-end retail and hotels – is in oversupply across many municipalities in China, due to the incentive of mayors to seek rent-paying tenants. Thus, a nationwide residential property tax might actually return the supply side of the market towards equilibrium as those distortions are mitigated.
- Axel Merk: The PBOC’s regulation of the cost of credit throughout the economy limits the supply of credit that is available to less creditworthy borrowers, such as small-to-medium-sized enterprises (SMEs).
- Axel Merk: Cheap credit isn’t necessary to get/keep an economy going. What economies need, rather, is a market-based system for pricing of risk. Financial repression actually slows growth in the velocity of money, as certain borrowers are crowded out of the credit markets.
- Michael Shaoul: The demand for real estate investment leads the demand for credit in China.
- BANKING SYSTEM
- Michael Shaoul: Since 2007, the Hang Seng Financial Index overlays quite well with the equity prices of Japanese banks in the four years post 1989.
- Joseph Taylor: The deposit rate ceiling acts as a subsidy to the state banks. Thus, the #1 problem with removing the floor is that [largely] unprofitable state-owned-enterprises (SOEs) will see their weighted average cost of capital increase as bank funding costs rise.
- Daniel Rosen: The Chinese consumer is stronger than meets the eye. Since 2003, nominal household consumption has doubled; there’s $500B-$1T in “grey consumption” (i.e. large propensity to spend abroad, unrecorded cash transactions, etc.); and Chinese consumption has grown faster, in real terms, than any other economy over the previous decade.
- Daniel Rosen: China desperately needs to further develop consumer vs. producer rights and establish intellectual property guidelines to reach a higher plateau of value-added consumption.
- Daniel Rosen: China must embrace regulatory reform in order to expand the market for higher-wage, white collar labor.
- CHINESE YUAN
- Robert Kapp: The RMB can’t ever become a free-floating currency without first liberalizing interest rates – which are ultimately a function of the liberalization of cross-border capital flows.
- CAPITAL FLOWS
- David Rubenstein: The U.S. invests about 5x as much money in China as the Chinese do in the U.S.
- Robert Kapp: Many Chinese investors are cynical towards their investment opportunities in the U.S. due to political resistance at the federal level, thus limiting the two-way flow of both foreign and portfolio direct investment. On the State and municipal level, however, many U.S. governors and mayors are welcoming of Chinese capital with open arms.
- DOING BUSINESS IN CHINA
- Robert Hormats: Intellectual property is an enormous problem in China. For example, to establish a joint venture in China – which is key form of FDI – a multi-national corporation essentially has to give away any/all its R&D and intellectual property, which ultimately gets pirated by “competitors”.
- CHINA vs. U.S.
- Robert Kapp: As China grows larger in economic and military might, it will seek to impose its own set of rules upon multinational organizations and international best practices. That said, Chinese international agents are very well aware of how certain systems benefit them and will no doubt seek to uphold those structures.
- Robert Kapp: Chinese policymakers are aware that it is in their best interest to keep the peace on the geopolitical risk front. Furthermore, there are certain stances that they are likely to ultimately choose to not defend – such as sanctions on Iran – if the alternative was to engage in international military conflict.
- POLITICAL LEADERSHIP TRANSITION
- Consensus among panelists: 2012 will be the “year of the status quo”, as China will seek to avoid any major changes ahead of or shortly after “handing off the baton” to the new leadership.
- Tim Adams: It would be surprising to see aggressive monetary easing in 2012. In fact, as Beijing has alluded to the entire way down, the State Council’s goal is to take the air out of the real estate industry. Further, they wouldn’t mind seeing consolidation in the over-supplied property development sector.
- Robert Kapp: The economic/market liberalizing reforms of the last 20-30yrs have essentially ground to a halt. It’s unlikely that China reaccelerates the pace towards Western-style capitalism in the near-term after witnessing the near collapse of the Western economic system in 2008/09.
- SOCIAL UNREST
- Robert Kapp: It appears that Beijing’s strategy in regards to dealing with social unrest is equivalent to “stomping out small fires” rather than enacting sweeping reforms to prevent such conflicts in the first place.