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China
is ground zero for stocks with mojo
6/6/2001
Hundreds of millions of Chinese hungry for
the trappings of the middle class are rapidly acquiring the means to pay for
them. Here’s why a new color TV in Guanghzou signals an opportunity in Peoria.
By Jon
D. Markman, MSN MoneyCentral
While
cleaning out my garage this weekend, an economic epiphany hit me like a cheap
toy falling from a high shelf: One of the real problems with the U.S. economy --
and, in turn, U.S. stocks -- is that most middle-class Americans don’t really
need to buy much more stuff.
We all
have more than enough cars, toys, razors, PCs, cell phones, bicycles, clothes,
washing machines and electric drills to collectively fill a garage the size of
Kansas. Marketing whizzes might persuade us to upgrade to a nuclear-powered
barbecue grill or try new mint-flavored, low-fat French fries on a stick. But
our needs, both real and frivolous, are pretty much covered.
Not so in
China, where a lot of the things I cleared out of my garage were made. There, it
seems, a middle class is finally emerging today after three centuries of
imperial decline and Communist suppression -- and they are turning out to be a
more potent consumer force than Western businessmen ever dreamed.
As a
result, the Chinese domestic economy is one of the few bright spots in the world
today, with annual gross domestic product growth clocking in around 7.5%,
compared to 1.5% or less in the United States and Europe. And stocks there are
responding as well, with several large Chinese companies that trade on the New
York Stock Exchange dramatically outperforming their U.S. and European
counterparts so far in 2001, including Huaneng Power International (HNP,
news,
msgs),
up 48%; PetroChina (PTR,
news,
msgs),
up 42%; Guangshen Railway (GSH,
news,
msgs)
up 80%; and Brilliance China Automotive (CBA,
news,
msgs),
up 26% through Monday. As one trader put it to me in an interview on Monday,
“China is hot with a capital H right now -- and it’s likely to stay that way
for some time.”
Rise of
the Chinese consumer
The
stealthy, steady emergence of Chinese consumers has far-reaching implications
for investors willing to take on a little risk by stretching outside U.S.
borders to find the sort of robust growth that’s missing at home. The most
reasonable way to take advantage of new opportunities is in mutual funds, such
as Matthews China (MCHFX).
It's up 49% in 2001 through Monday, the third-best return in the nation of any
fund type. It's run by experienced fund managers who can visit the growing
number of small-cap companies traded on Shanghai and Shenzhen stock exchanges.
But in addition to the Chinese stocks listed above, area experts believe cell
phone services giant China Mobile (CHL,
news,
msgs),
PC maker Legend Holdings (LGHLY,
news,
msgs)
and transportation leader China Southern Airlines (ZNH,
news,
msgs)
should also represent the vanguard of change.
Why
bother?
You have
to look beyond the Bush administration’s drumbeat of anti-China propaganda --
this week it was reported that the Defense Department has cut off the
Pentagon’s contacts with military counterparts in Beijing -- to see that
reformers in the ruling party are finally throwing aside most barriers to growth
in an effort to join the World Trade Organization by the end of the year, and
fulfilling the world’s everlasting hopes about the potential buying power of
the world’s most populous country.
On
Monday, the Asian Wall Street Journal reported that AOL Time Warner plans to
make its first entry into the Chinese market a whopper -- tapping the
country’s leading PC maker as a partner in a $200 million joint venture for
interactive services. In addition, consider a few metrics compiled by Matthews
International Capital Management in a recent report:
-
China recently
passed Japan to become the second-largest mobile phone market in the world,
according to CLSA, the emerging-market arm of Credit Lyonnais. It is
expected to have more than 110 million subscribers by the end of 2001, and
more than 250 million by the end of 2005.
-
China has the
fastest growing PC market in the world, with a five-year compound average
growth rate of 28%, according to International Data Corp. Compare that with
the United States, where the growth rate is pegged around 8%, and Europe, at
14%.
-
The number of
Internet users in China has almost doubled every six months since 1997, and
today you can find about 25 million buddies to chat with online in Cantonese
or Mandarin.
Stereotypes
in the U.S. media continue to portray the Chinese workforce as prisoners on an
assembly line or pre-teens in a sweatshop. But the reality is that spending on
all that telecommunications and technology is in large part a reflection of the
widening horizons and ambitions of an expanding middle class that is made up of
skilled workers in coastal cities who increasingly produce world-class finished
goods.
According
to Goldman Sachs, China has become the globe’s second-most popular destination
for foreign direct investment in the past two years. As a result, it has
surpassed former tigers Singapore, Korea and Taiwan to become, in Goldman’s
words, “the manufacturing base of East Asia.” The scale is breathtaking.
Today you can drive 60 miles from Hong Kong to Guangzhou (formerly known as
Canton) and see factory after factory after factory. Goldman notes in a report
published Friday that the most dramatic trend has been a shift of operations and
outsourcing to the mainland by Taiwanese and Korean technology giants. But major
recent investments also include a $4.1 billion joint venture by Royal Dutch
Petroleum (RD,
news,
msgs)
with China National Offshore Oil; a $300 million chip-packaging plant in
Shanghai announced by IBM (IBM,
news,
msgs)
and a $200 million expansion by Intel (INTC,
news,
msgs)
in its Shanghai chip assembly and testing plant. This is not “hot” money,
but projects that are expected to play out over many years -- not quarters.
The
better-paying jobs at these factories go to TV-watching urbanites susceptible to
all the marketing messages that afflict Westerners. So far, according to
Matthews researchers, about 10% of the 200 million people in urban China have
achieved middle-class status -- which is defined at an annual income of $4,000
U.S. – even though they are paid one-tenth of what comparable workers get in
Taiwan or South Korea. Procter & Gamble (PG,
news,
msgs)
learned that they were able to make Head & Shoulders shampoo a top brand in
China by stigmatizing dandruff in a breakthrough advertising campaign. Here’s
the rest of their shopping list, according to Matthews China portfolio
co-manager Mark Headley:
-
They will
definitely get a cell phone.
-
They will replace
their current 13-inch TV with a newer, 27-inch model.
-
They will remodel
their apartment.
-
They will buy a PC
and hook it up the Internet.
-
They want to buy a
new car but will have to save for a couple of years to afford it.
Increase
in homeownership, spending
The third
category merits further explanation. Up until the mid-1990s, state-owned
enterprises and local governments owned most of the urban apartments in China
and rented them to citizens for around $10 a month. But party reformers hatched
a plan to privatize the housing market and began to let people buy their homes
at rock-bottom prices. This lead to a “huge transfer of wealth,” says
Headley, as apartments worth $10,000 were sold for $3,000 by the government. You
had to wait a few years to sell, but hundreds of thousands of Chinese earned
windfall profits by ultimately reselling their homes for three to four times
what they paid. About 85% of Shanghai housing stock is now privately owned, up
from 5% eight years ago. With bank capital freed up for private use as well, you
can get a 5% 30-year mortgage in Guangzhou today.
One
result: An estimated 450,000 home-improvement businesses have emerged.
“Homeownership is the foundation of the middle class,” notes Headley.
“Once you own a place, you immediately start pouring money into painting,
putting in hardwood floors, etc. -- and you start feeling better about yourself
and your family’s prospects.” It’s not hard to imagine that in 10 years,
China will be a more important market for the Sony Playstation 8 than the United
States.
Global
derivatives trader Gitanshu Buch further points out that the Chinese government
has authorized an increase in wages for government employees. The last increase
was 30% in 1999, Buch says, and resulted in an immediate uptick in local retail
sales and stock investments. So here’s the virtuous circle: Rising foreign and
domestic investments lead to higher wages, which leads to higher consumption,
which leads to a wealth effect, which leads to higher stock investments that
feeds the wealth effect … Sound familiar? Already, Matthews estimates that
there are 50 million individual brokerage accounts in China.
To be
sure, if you go 1,000 miles inland in China the country is still massively
agricultural, dotted incongruously with “Iron Ricebowl”-era steel-mill
smokestacks pumping pollution into the sky and water. And corruption is still a
problem, although authorities say that an intense government campaign to round
up and shoot bribe-taking officials by the busload is starting to have a
chilling effect. (Says Headley: “They have just been killing corrupt
government officials at a horrendous rate. … If you demand a bribe in China
today, you are risking your life.”)
Yet when
it comes to stocks, the bottom line is psychology. As Buch points out, a lot of
money in the world is run on relative strength, and the simple fact is that
China is ground zero for mojo
at the moment. With GDP growth head and shoulders above the United States and
Europe, industrial production coming in at 18% annually (versus 2% for the G7
countries) and “B” shares (ones listed only on Chinese exchanges) having
tripled so far this year in part due to some one-time local investment-policy
changes and currency deregulation, it looks like trends favor Chinese stocks.
Looking closer, it appears that the focus has shifted to the cyclical shares
listed in Hong Kong known as “H” shares, which are trading at a 50% to 75%
discount to the B's. On Monday, three of the top 10 NYSE performers were in this
category: Jilin Chemical Industrial (JCC,
news,
msgs),
up 25%; Guangshen Railway, up 12%, and Sinopec Bejing (BYH,
news,
msgs),
up 11%.
Of
course, this rally will fizzle eventually. The last time Chinese stocks
outperformed -- from mid-1996 to mid-1997 -- it was over expectations that the
Hong Kong handover would go smoothly. The move ended in tears with the Asian
financial crisis (which really wasn’t China’s fault). It’s fair to assume
that this move, which started in February, could last at least a few more months
, particularly if current skepticism continues and the rest of the world’s
economies fail to perk up in the second half on cue. Although I usually focus on
stocks in this column, I’ll defer to mutual funds this time because of the
difficulties of direct investments overseas. Here are the top-ranked no-loads
for the past year and three-year periods. I will track the top three over the
next year and update you on their progress.
|
Fund
Name
|
YTD
% Ret.
|
3-Year
Ann. % Return
|
|
Matthews
China (MCHFX)
|
49.6
|
4.03
|
|
Matthews
Korea (MAKOX)
|
22.3
|
18.77
|
|
Fidelity
Advisor Korea A (FAKAX)
|
4.5
|
15.94
|
|
Matthews
Pacific Tiger (MAPTX)
|
9.5
|
14.02
|
|
Matthews
Asian Growth & Income (MACSX)
|
10.1
|
14.98
|
|
Pacific
Capital New Asia Y (PCASX)
|
3.2
|
6.68
|
|
Alliance
Greater China '97 Adv (GCHYX)
|
1.98
|
11.23
|
|
Liberty
Newport Greater China B (NGCBX)
|
1.94
|
11.94
|
Source:
Morningstar
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