China: Why the Dragon Is Slowing

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Seven percent GDP growth. Doesn’t it sound wonderful?

china-package-185I would wager that just about every Western leader would be willing to commit murder for 7% GDP growth. American GDP growth is clocking in at 2.7%. German GDP growth is at 1.6%. And that perpetual sluggard Japan? Its economy is actually shrinking and hasn’t had meaningful growth in two decades.

But if you’re China, 7% GDP growth isn’t all that great. In fact, from the way the media bangs on about it, it’s almost like having a recession. It’s certainly a far cry from the double-digit growth rates China was enjoying as recently as 2010.

And given China’s penchant for … ahem … engaging in creative accounting, even that 7% number is looking a little suspect.

Is this just a garden-variety cooling? Or is the great China growth story finally over?

It’s actually a little of both. China is transitioning from labor-intensive manufacturing economy into a more modern, Western-style service economy. And as that transition happens, there will be bumps along the way that are part of this evolutionary process. That’s the good news.

The bad news is that China massively overbuilt during the boom years and now has overcapacity pretty much everywhere you care to look. Overcapacity leads to deflation, which in turn leads to an abrupt halt to new investment.

In other words, the new China will be one of slower (though arguably more sustainable) growth.

Let’s dig into the details.

Slower Growth Will Weigh on Chinese Stocks

The Federal Reserve and U.S. government take lot of heat these days for inflating asset bubbles with ultra-loose monetary and fiscal policies. But the U.S. really can’t hold a candle to China when it comes to blowing bubbles.

Cheap financing and massive construction spending led to a construction boom which quickly morphed into a housing bubble, particularly in the years following the 2008 meltdown. Construction spending reached a ridiculous and unsustainable 10.4% of GDP. To put that in perspective, at the height of the mid-2000s American housing bubble, home construction peaked out at about 6.5% of GDP.

To further put it in perspective, China built so much new living space in the past decade that per capita floor space ballooned to 30 square meters. Japan, a much wealthier and more developed nation has only 22 square meters of living space per person. And remember, China is a country with a population of 1.3 billion people. That’s an almost unfathomable amount of building.

Sure enough, prices began to soften in 2013. But as speculative money sloshed out of the housing bubble, it sloshed right into the Chinese stock market, creating a new bubble in Chinese stocks.

Take a look at the Deutsche X-trackers Harvest CSI 300 China A Shares ETF (ASHR), which tracks the Chinese A-shares available to local investors. Between November and June, the price more than doubled. Chinese stocks, fueled by lax margin loans, went vertical.

ASHR

Of course, we know what happened next. Chinese stocks utterly collapsed, and ASHR came crashing back down nearly to where it started its ascent.

The collapse of the China stock market has led a lot of China watchers to predict a major recession. I’m less concerned about that possibility. Yes, a market crash is unnerving and rattles investor confidence. And in China’s case, you have the added risk of $358 billion in margin loans potentially going south.

But as Barron’s recently pointed out, only about 50 million Chinese investors out of a population of 1.3 billion people actually invest actively, and Chinese households only had about 5% of their net worth in stocks.

The far bigger risk to China is a repeat of what happened to Japan: a prolonged malaise brought on by aging demographics. For an emerging-market economy, China is remarkably old. The median age in China is 37, the same as in America. And it’s getting a lot older. The number of people above age 60 in China is projected to increase to 437 million, or 30% of the population, by 2050. That’s roughly double the proportion it is today.

Japan is living proof of how hard it can be to grow an economy with a graying population, and China faces the same bleak future.

So, while some of China’s current slowing is simply due to the reorientation of China’s economy away from mass manufacturing, we can’t really expect China to ever return to the 10% growth rates it enjoyed for large swaths of the 1990s and 2000s. Demographics have all but doomed the country to permanent slower growth.

Charles Lewis Sizemore, CFA, is the chief investment officer of investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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Article printed from InvestorPlace Media, https://investorplace.com/2015/10/chinese-stocks-dragon-slowing/.

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