Tricky transition: China’s move to consumer growth

This is why so much attention has been given to its slowing growth rate: when China slows down, so does the rest of the world. The most obvious example of this phenomenon so far is the ending of the so-called ‘commodity supercycle’.

Driven by the extraordinary growth of the Chinese economy, its spending programmes on infrastructure, property and other projects dragged global mining companies’ profits in particular to new highs, and led commodity exporting countries such as Australia and Brazil to high economic growth by association.

But now that China’s economy is slowing down and it is looking to move away from an investment-led economic growth programme towards a domestic consumer-led approach, shares in mining companies, and in countries that rely on exporting commodities, have suffered. In sterling terms, the Brazilian Bovespa index fell by 28 per cent last year.

It has not just been a slowdown in China’s voracious appetite for commodities that has caused both Asia and emerging markets to underperform developed markets in the past few years, but it has contributed.

While the main reason has been a shift in foreign money flowing out of those regions in the face of weaker global growth, a process that was exacerbated by the slowdown in US quantitative easing, paranoia around China’s economy does seem to be an underlying factor.

It got to the point last year that, according to star Artemis managers Adrian Frost and Adrian Gosden, the stockmarket seemed to expect China never to build anything ever again, when in reality it was still ploughing money into infrastructure projects.

The realisation of this may be one of the reasons that the Brazilian Bovespa index has bounced back from its fall in 2013 and has generated considerable returns so far this year. In spite of a mixed recent showing, mining shares are also up in the past year.

The slowdown in China and emerging markets has also affected a lot of Western multinational firms that relied on the region for growth, such as banks HSBC and Standard Chartered, and consumer goods companies such as Unilever. Again, however, these companies have experienced mini-revivals in recent months.

In fact, China itself is one of the few areas not to have enjoyed a stockmarket boost recently.

Financing an evolution

The reasons for that are encapsulated in a recent HSBC report on the region which explains: “There has been growing concern about China’s shadow banking system and corporate default risks. The investment boom since 2009 has given rise to over-capacity in several sectors, excess supply in the property market in some cities, and a surge in corporate leverage and local government debt.

“The credit boom and high leverage will inevitably lead to financial losses and corporate defaults, as interest rates rise and economic growth slows.”

Axa Investment Management’s Aidan Yao thinks the country’s property market is in particular danger, saying that it is “constrained by an oversupply of housing, tight credit conditions for developers and the government’s anti-corruption agenda”.

He thinks a correction of 10 per cent in China’s housing market could result in a 2 per cent drop in the nation’s GDP.

However, Mr Yao thinks policy easing from the Chinese government with mitigate the worst of the correction, much as many observers think the government has the capability to avoid the worst of the problems that could be generated by the shadow banking system.

The impact of these fears has seen the stock market decline this year to reach a very low valuation, around 9 times price to earnings (p/e) according to one measure.

That valuation is skewed by a number of state-owned enterprises on its exchange that are always on a low p/e number, but the bearish conditions are beginning to win round investors that were previously hesitant about China.

The well-respected Asia and emerging market equities First State Stewart team recently visited China and, in an update to investors, the team said the slowdown in growth in China had made the companies there begin to think more seriously about how to improve their businesses.

First State said companies in sectors such as healthcare and consumer goods were now beginning to innovate and, while China has historically had relatively few multinational companies, the “global footprint of the country’s multinational companies is growing”. The team claims “this should make the next few years interesting from an investor’s perspective”.

While China is likely to continue to influence the world through its consumption of commodities, it is increasingly exerting weight through the power of its consumers and the improving strength of its business.

Whether an investor looks to access that through Western companies, investing in Asia as a whole or through the cheap Chinese market itself, it will prove hard to ignore China through the next decade.