Chinese equity investors have had a torrid year. Over the past twelve months, moderating GDP growth, continued fears over a credit “bubble,” and the beginnings of a bond market correction have driven Chinese markets down 9%. To make the story worse, developed markets advanced 17% in the same period. But with the backing of a well-capitalised sovereign, low external debt, and well-contained inflation, we feel the issues have been over-stated. As investors who favour opportunities “away from the herd,” we look beyond headlines and take the time to examine the Chinese economy from the bottom up.
We continue to believe in specific pockets of opportunity in China, especially with respect to the rise of the consumer. McKinsey recently forecast a 250% expansion in private consumption by Chinese households by 2022, including a five-fold increase in those deemed to become “upper middle class.” Data compiled by Bain show the rapid emergence of China within the global luxury goods market, having recently overtaken Japan, the United States, and Europe as the dominant buyer group.
At the same time, the Chinese economy boasts plenty of capacity for consumption growth – the consumer sector represented less than 35% of output in 2012, compared to nearly 70% in the US. Similarly, the savings ratio in China stood at 51% in 2012, compared to 17% in the US, and 22% and 31% in regional competitors Japan and South Korea.
Misplaced investor focus only adds to the rationale: consumer related business comprise less than 14% of Chinese index capitalisation, compared to over 30% for developed markets. Despite robust underlying fundamentals, discretionary consumer businesses in China trade similarly to the wider Chinese market, with a forward P/E ratio of just over 10, against more than 16 for the United States. Put into context, the lowest level US forward P/E multiples have been over the past 25 years is a little over 11 which was at the height of post-crisis turmoil.
Ultimately, and in spite of deteriorating fundamentals, investors have continued to “play” China through energy and financials rather than consumer stocks. As long term investors, we are more than happy to take advantage of the resulting dislocation.