China – Perception vs. Reality

Chinese stock markets bottomed out earlier than domestic stock markets (October 2008 vs. March of 2009 for the S&P 500), and have now rallied over 90% since then on a timely and well executed stimulus package. Proponents of the Asian emerging growth story cite that China has less debt, higher economic growth rates, and none of the financial balance sheet problems that have plagued their developed counterparts. But for every bull there is a bear, and the bears seem to believe this market is setting itself up for another boom/bust scenario. Many bears believe that China has huge excess capacity built up, and that its main driver of growth has been exports to the West, much of which was fueled by an overbuild in debt, a shadow banking system, home equity withdrawals, etc. The proponents of this view see no fundamental reason for China’s rally, especially since their main US customers are bound to be in a deleveraging cycle for years to come.

Recently I read a research piece that listed a breakdown of China’s growth drivers, and the numbers implied that China may be less export dependent than most investors perceive it to be. I have to admit that I was surprised to see that the percentage of Chinese GDP driven by exports currently represents less than 10% of the total, while consumption and investment represent approximately 92% of current growth (see chart below). Residential consumption itself is actually more than a third of total growth, though it has slowed as exports and foreign direct investment have accelerated in recent years. My view regarding China has been that there are still strong linkages between China and global consumption, and I think the last downturn reinforced to me that some connection clearly still exists. However, the facts are the facts, and investors (including myself) must always be mindful to not ignore them as they attempt to square perception versus reality on any investment thesis. To say that exports are not important to China would be a misstatement. However in this case it appears that the perception of China being primarily dependent on exports is also misleading and ignores the reality that China gets a significant percentage of growth from consumption. And that’s a percentage that may be bound to grow in future years given that the country appears to be in the early innings of a transformation that will take it from an emerging market into an industrialized nation.

Chart Source: Ned Davis Research