China's back, baby!
Not with a vengeance, but with a steady-as-she-goes economic engine that bottomed in the second quarter and is slowly turning the corner.
China's official Purchasing Managers Index (PMI), released Sunday evening, dipped slightly to 50.2 in June from 50.4 in May, but was still better than market expectations of 49.2. The slight decline should be interpreted as a positive sign. China's National Bureau of Statistics' PMI index has dropped by 1.1 points on average between May and June in the past seven years. Interest rate cuts and other monetary easing measures since May are, with the accustomed lags, starting to filter through to the Chinese economy.
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China's benchmark interest rate is around 6.3 percent and was cut in June for the first time since 2008.
The bull case, and even the neutral case on China is that the government still has lots of arrows left in their quiver. It can and will likely lower reserve requirement ratios at banks to free up lending. It has tons of cash, running a current account surplus. What does that mean to the non-investor? It means China doesn't really have to go to foreign lenders to raise money to pay for its government obligations. Public debt to GDP is around 17 percent compared to around 75 percent in the U.S., more than 100 percent in some European countries and around 120 percent in Japan.
China is slowing down because it is going through a structural shift in its economy. No longer wanting to be the Made in China manufacturing hub of the world, exporting the world over, China is focusing inward and that takes time and slows growth during the transition. Moreover, the European debt crisis has hit China particularly hard because that's China's main trading partner. China is also slowing because the world economy is slowing.
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But recently, portfolio managers are starting to look at China and think that there are bargains to be had in the world's No. 2 economy after the U.S. China, they believe, is not heading for a hard landing. China is going to turn out okay, and despite the fact that this year will remain volatile because of Europe and probably because of the U.S. "fiscal cliff", whereas the Congress has to go through raising the debt ceiling again before the year's out, if investors want to eek out double digit or triple digit gains in the long run, now is the time to like China again.
Audrey Kaplan, a fund manager at the Federated InterContinental fund (RIMAX) recently got back into China in the first quarter after nearly a two year hiatus. Their in-house proprietary investment models now have China as an overweight to the MSCI All Country World ex-U.S. index.
"Our models suggest that inflation pressures will stay low through all of 2012, and we think policy makers can ease to support growth," Kaplan says. "This slow down will give them the push they need to stimulate the economy." It's not a foreign view. It's just that many investors are now seeing things the same way, and Kaplan is finally putting money on the table.
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Kaplan has gone from a zero weighting in the Federated InterContinental mutual fund to a 9 percent weighting in less than a quarter. How's that for standing by your conviction?
Rattling off names from the top of her head during a phone interview Monday morning, Kaplan said she recently bought Baidu (BIDU), China Mobile (CHL), Air China (HK:0753.HK - News), Golden Eagle Retail Group (HK:3308.HK - News), Great Wall Motor Company (HK:2333.HK - News) and Dongfeng Motor Group (HK:0489.HK - News).
Then there's the issue of Chinese economic data. Just how well is China doing? Can you trust the Chinese government's numbers? Kaplan doesn't putting all her trust in what prints out of the National Bureau of Statistics. She's got people on the ground interviewing CEOs for business sentiment and inventory levels — are they selling what they're making?
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"We are using at least three firms in China that are providing us with information. Plus one of my own teammates goes to China visiting Chinese corporations or some of the big multinationals to get a sense of what they're thinking about the market. You can't just rely on a single data source. You have to do research. That's how I spend 98 percent of my time. We're very process oriented, constantly updated and scrubbing from probably more than 30 sources. It's like a puzzle. There's a lot of different information out there and you're just putting together your own prediction."
Andrew Milligan, head of global strategy at Standard Life Investments, a $256.7 billion asset manager in Edinburgh said he held a similar view on China, that inflation was coming down and that would help the Central Bank with interest rates. There would be no hard landing. The economy will likely end the year growing by 8 percent, far from the under 7 percent many economists say would mean a hard landing.
"We are not China bulls by any means," Milligan says, adding that he was concerned about bad loans at China's big banks, but didn't doubt the government's ability to take care of them in a worst case scenario. "The economy might not be as strong as people think," Milligan cautions.
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China is the fastest-growing major economy in the world. Its rapid growth was bound to slow and savvy investors no longer count on double digit GDP in China. That doesn't make China less attractive. Many stocks are cheap, and this is the way long term investors buy low and hope to sell very, very high later on.
This year, China is expected to be the single-largest contributor to world GDP growth, accounting for a full 40 percent, more than double that of the United States, notes Jeff Shen, portfolio manager of BlackRock's Emerging Markets Long/Short Equity Fund.
"We believe China will emerge as the 'engine that could'," Shen says. "China should have the means and will to remain a powerful force on the global stage."
