Three Men Make a Tiger

An ancient Chinese proverb warning against groupthink tells of how a high-ranking official once asked his King: would you believe a cry that a tiger was free in the marketplace? When the King answered no, the official asked if he would feel the same should a second subject repeat the claim. The King replied that he would start to wonder. And what if three people declared that a tiger was loose in the marketplace, asked the official? Then, the King replied, he would surely believe it.

Put another way, the Chinese have long known that ‘consensus’ can be a dangerous thing. The global consensus today is that China is an economy suffering from inadequate consumption growth, high leverage, a construction bubble, unsustainable demographics, optimistic GDP targets, and inefficient state-driven investment.

But China is complex. The Shanghai stock market rose 61% in 2014, whilst the Hong Kong exchange rose just 9%, showing returns can differ depending on where investors are permitted to trade. The People’s Bank of China tightened monetary policy in 2013, and unexpectedly eased it in 2014. 70% of investment and 80% of urban employment in China stem from private, not public, firms, and in 2013 services contributed more to GDP (46%) than industry and construction (44%). Consumers are enjoying 10% real wage growth with 1.4% inflation, and grew retail sales by 12% last year. The economy has limited mortgage debt, a 50% savings rate, and external debt covered nearly four times by foreign currency reserves. And China is increasingly resilient to external shocks: exports made up 26% of GDP in 2013, down from 39% in 2006.

This in addition to a central government determined to prop-up growth and increase living standards, an anti-corruption drive with bite, meaningful reform of state-owned enterprises, and continued wholesale market liberalization (including Renmimbi internationalization and major steps in opening the domestic A-share market to foreigners.) And valuations are attractive; Hong Kong equities are still down 25% from October 2007 in a Chinese economy over 60% larger.

We spent ten days in Asia late last year trying to determine the real ‘on the ground’ story, and came away with a much more sanguine view than that in the media. From the outside looking in, news headlines are often the only (or the simplest) gateway, and it is all too easy to form a view lacking a fundamental basis. ‘Conventional wisdom’ is often neither, and we would caution against betting against China’s economic momentum just yet.