Its pretty rare for me to have strong views about macro events. Generally speaking, I think one is likely to be far more successful in investing by focusing on the micro factors. However, in recent times, I have been building increasingly strong views about China, and i felt compelled to share my thoughts about the issue I think is the most important, not only for Australian investors, but for each and every person in Australia today. You often here about Chinas ‘export driven’ economy or how the Chinese consumer is the key growth pillar. These are common misconceptions about China. In actual fact, the key driver of the Chinese economy is not exports or consumption, but investment (or ‘gross fixed capital formation’ as the Chinese statistical bureaus call it). Investment makes up nearly 50% of Chinese GDP, a level which is truly amazing, and as far as I am aware, unprecedented in modern times. It seems most economies average investment of around 20% annually. I have searched and the only other economy I have found that has come close is Japan in the 1970’s and 1980’s, topping out close to 40% right before their zombie double decade. Even during Australia’s own surge in mining capex in recent times, investment only just touched 30% of GDP. As investment is the largest component of Chinese GDP, its future direction is the key swing factor for the whole economy. If absolute investment declines, the other components (consumption, government expenditure and net exports) have to increase by a much greater degree just for GDP to stand still. Just like an investment portfolio with a 50% position, if that position declines, the other positions have to shoot the lights just so the portfolio can break even. For the visually inclined, I posted my chart of Chinese GDP earlier today. In a highly underdeveloped country, investment into roads, bridges and buildings can add meaningfully to the economy’s productive capacity, and therefore it makes sense to dedicate a large amount of resources to this area. For many years, this was China. However, all good things eventually come to an end; economically viable projects are not unlimited. If investment continues into marginal projects, debt increases but this is not matched by debt servicing capacity; the definition of unsustainable. I think this is beginning to surface in Chinas numbers, with slowing GDP growth while credit growth continues to compound at around 15%. And debt levels are building to concerning levels. There is no shortage of reports on over investment and surplus capacity. Vacancy rates for residential property are currently around 20%. And despite this, China is set to build even more floor space at an astonishing rate. Hamish Douglas from Magellan estimates China has 4-5 years of surplus housing capacity, an amount equal to what America had in the years before the sub-prime crisis. I certainly agree that China has the ability and desire to smooth any bumps in the road. If it came down to it, the government has the tools to get the economy out of trouble. However, I believe Chinese GDP growth is the wrong metric to focus on. The composition of the GDP is what is important for us as Australians, hence the biggest risk for Australia is lower Chinese investment, whether it comes from an orderly transition due to a shift to a consumption driven economy or a disorderly downturn due to a debt induced shock. Given our world class mines, Australia probably has a 20-30% share of the inputs in a building or bridge, yet a comparatively minuscule share in the inputs of the daily habits of the emerging consumer class. An as investment is the ultimate pull forward of demand, I believe a period of under investment is likely to follow a period of over investment in order for an economy to reach a sustainable footing. If you cram 50 years of investment into 20 years, what happens in the following 30 years? My fear is that Australias status as the lucky country is about to change. Predicting rain is one thing, building arks is another. I dont have any interest in shorting Chinese developers or Fortescue, i’ll leave that to Jim Chanos. Timing becomes very important in that game and I dont back myself on that front. My main priority is to mitigate my exposure to this risk. For starters, I know where I dont want to be invested, such as high cost miners, economically sensitive Australian businesses as well as those with an import bias. Having extra cash on hand is also key, as if the worst case materializes it is likely to produce an incredible buying opportunity. I think it is likely that the Australian dollar will be significantly lower over time, hence gaining exposure to exporters and business with foreign earnings is the right place to start. I have my finger on the trigger of a few new names which play into this theme nicely; I hope to be able to write about them in the coming weeks.
Posted on: Thu, 07 Aug 2014 07:33:14 +0000
Trending Topics
Recently Viewed Topics
© 2015