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China: The Eight Percent Game

By Yiannis G. Mostrous on June 14, 2012

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As the Chinese economy grapples with its own domestic challenges, the consequences of the euro zone crisis and the anemic economic growth of the US, investors should also understand that the Chinese economy is not on the verge of collapse.

Without ignoring the long-term challenges that still face the Chinese economy, it’s our view that the Middle Kingdom is set to deliver a solid 8 percent growth in gross domestic product (GDP) this year.

To be sure, the Chinese government has been trying to wring out speculative excesses—efforts that have resulted in a sharp slowdown in infrastructure spending and residential investment. These were necessary moves, because over the past seven years China has undergone a huge infrastructure investment phase and the construction sector was overheating fast.

Chinese officials have been very careful to not repeat the Japanese mistake of the 1980s, the famous “bridges to nowhere” orgy of construction during Japan’s heyday. However, at the same time, the government wants to refrain from choking economic activity.

The country’s infrastructure requires considerable investments, not only in roads and bridges, but also in airports, energy, water distribution, and safety. Consequently, infrastructure spending has been picking up since the beginning of the first quarter.

Admittedly, the residential sector is not in good shape. The growth rate of residential property investment has slowed below 5 percent this year, down from strong double-digit growth last year.

However, the government has been gradually relaxing restrictions on residential property investment, especially for first-time buyers, and the market is starting to perk up. By the fourth quarter of 2012, the residential market will be on a much better footing, as new buyers enter the market and push up prices.

Investors should keep an eye on how property performs in the smaller Chinese cities. Smaller cities are strategically important to the housing sector, because they contain more than 60 percent of the population. Consequently, any rebound of the property market in smaller cities will be the final bullish signal for the real estate market in China.

In the meantime, the recommendation here is to ignore all the loose talk about a collapse in the Chinese housing market, at least for the short term.

China has no sub-prime mortgages, no mortgage securitization industry, and very few home equity loans. In other words, the market is “unsophisticated,” which proves to be a positive trait these days.

For some time the view here has been that the era of double-digit GDP growth in China is over, as the country tries to stabilize and increase the number of people that can participate in economic growth. As a result, any growth above 7 percent should be seen as a positive for China’s future, because it reflects sustainable growth.

The country is trying to change the quality of its growth, a task that presents many challenges. However, a hard landing this year is not in the cards. Although stimulus will be used when necessary, as indeed is happening now, the massive moves of 2009 will not be repeated any time soon, unless the European or the US economies collapse.

If there’s a country in the world that can easily go ahead with a stimulus plan, it’s China. Total government debt in the country stands at less than 40 percent of GDP, a figure most other countries would envy.

Despite these encouraging trends, negative investor sentiment reigns supreme, which poses a contrarian opportunity. At current levels, emerging markets in general and Asia in particular offer a good entry point for investors.

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