SHANGHAI — For the itinerant financial journalist flying into Shanghai these days — is a jarring disconnect between the worrying news in the outside world concerning China and the bustling reality on the ground.
Outside of the People's Republic of China, the news is all about the risks of a bursting property bubble, or of rising worker unrest, or of a slowing economy as exports to Europe or the U.S. fade. Once in Shanghai, you feel like you're in any European city, except that the buildings are much taller and the signs are in Chinese. Late-model Japanese, European and even American cars clog the streets, and well-dressed Chinese men and women throng the sidewalks. Not a bicycle is to be seen since these days wealthier people drive cars while the less well-heeled ride on a shiny new subway that in 15 short years boasts more than 400 miles of track, making it bigger than the huge but creaking century-old New York City subway system.
Of course, Shanghai is not all of China by a long shot (and all of China is certainly not like Shanghai), but it is the commercial heart of China. Meanwhile, the reports from the hinterland are pretty stunning too.
"Things are amazing in China," exclaims an enthusiastic Sean Lynch, global investment strategist for Wells Fargo Private Bank. Lynch reports that he was in both Shanghai and in Chongqing, a huge city/administrative region of over 30 million people in the center of the country. "Shanghai certainly looked busy," he says, "but so does Chongqing." With considerable understatement, he notes that the latter city is "in the process of building out," with massive numbers of apartment buildings being constructed apace to accommodate all the new workers moving in from the countryside. "You don't see many empty buildings in all that construction," he says.
Lynch is quick to admit that there are "a lot of short-term concerns" about China's economy and about its political system, which is about to undergo a change of leadership at the top. "People don't know if the tightening that the Chinese government did in 2010 [to tackle inflation and concerns about a property bubble] is starting to have an effect, or whether they should now loosen credit so that they don't have a hard landing," he says. "And then there are concerns about slowing exports because of the problems in Europe." That said, Lynch adds, "We're coming back from our trip to China feeling that we should continue to overweight emerging markets, but remain neutral on China, not negative." At the same time, he says, noting that the Chinese stock market dropped 21% in 2011, "One thing that gives us comfort about China is that valuations on the equity side look pretty reasonable right now. That gives us a way in if we want to increase holdings in China."
Even more enthusiastic about China's investment prospects is Brian Rose, senior investment strategist at UBS. "We have a positive view of China," he says. "Some of the problems there have led investors to flee the country, and now it's actually cheaper than the average emerging market. So actually, while we see all the problems-social unrest, property bubble and so on — still we think the long-term growth story is compelling, and because of all the concerns investors have had, the valuations are actually quite low." He adds, "If investors can overcome their fears, we expect to see more positive news about China coming in the second half of this year."
Quincy Krosby, a market strategist at Prudential Financial, says making predictions about the direction of the Chinese economy, and about the potential for Chinese investments, got a little harder lately, because of the central government's intervention in China's equity markets. "It used to be that we looked at the Shanghai Index as a leading indicator for global markets," she says, adding that it also gave some indication about when the Chinese economy was expanding.
But Krosby says lately, after a bad year for Chinese stocks, the government had intervened by using its new sovereign wealth fund, and also by instructing Chinese insurance companies and financial companies to join it in investing in equities, thus "manipulating" the market. "So now we're looking for other confirmation that things are turning toward growth," she says, citing the Australian dollar gaining strength, or industrial metals picking up." The evidence, for example, of rising copper prices, suggests that this is starting to happen.
For now, Krosby suggests that investors can benefit from Chinese growth more safely by investing in companies that have substantial investments in China, particularly those that are playing for the Chinese consumer market. These include Yum! Brands, which is opening prodigious numbers of new Pizza Hut and KFC outlets in China, and also McDonald's. General Motors, too, is big in China, where it reportedly sold more cars last year than it did in the U.S.
David Falkof, a fund analyst at Morningstar, notes that investing in Chinese B-shares ( the Chinese stocks that are available to foreign investors, and which are traded in Shanghai and Shenzhen primarily) can be "pretty volatile," and is thus not for the faint of heart or short of knowledge. At the same time, he notes that most of the scandals in recent years have involved Chinese companies that have ADRs trading on western developed country stock markets. He suggests that the safest Chinese stocks, in terms of transparency and risk, are H-shares — Chinese companies that trade on the Hong Kong Stock Exchange. In order to be listed on the Hong Kong exchange, he notes, a company must first show three consecutive profitable years of operation — a requirement that largely eliminates a common ploy where a Chinese company seeking a foreign listing will do a reverse takeover of a shell company before listing.
Falkof says that for those investors who want to add Chinese equities directly to their portfolios, there is the Matthews China Investor Fund, which boasts a coveted Morningstar Gold rating. "They have a mix of big Chinese companies and stocks that are actually protected when investors flee the market because they have been under-covered," he explains. The fund invests in both B-shares and H-shares.
The Matthews China Investor Fund (MCHFX) was down last year by 16%, compared to a drop of 24% in the China Index and to a drop of 23% for the average China fund.
Richard Gao, lead fund manager for the Matthews China Investor Fund, says, "There are a lot of concerns right now about China's economy, and there's a lot of skepticism among foreign investors, but we take a three-, five- or even 10-year horizon, and when you do that, you see that the living standards of Chinese people have been improving dramatically, and will continue to do so." GDP, which had been growing at almost 10% a year for decades, "may not continue at that rate, but there will still be great growth opportunities in the domestic consumer area." That is the sector where his fund focuses — doing bottom-up company-by-company research on companies that are producing high-value-added products for the domestic market.
Over the years, one relative constant that has acted as a kind of backstop for American investors in China has been a gradual appreciation of the Chinese currency, the renminbi, against the U.S. dollar. For long-term investors, this appreciation has meant that even if Chinese equities markets can be pretty volatile, holdings in the local currency tend over time to be worth more in U.S. dollars anyhow.
Tan Hok-Kee, treasurer of the Chinese joint-venture subsidiary of global drug firm Merial, said in November that even though his Chinese veterinary drugs operation was doing so well that he needed to build a new $70 million factory to meet demand, and even though the parent company was loaded with cash, he's had trouble building the new plant. Local contractors, it turns out, are demanding payment in renminbi, not in steadily depreciating U.S. dollars. Meanwhile, the central government has been tightening local currency lending to keep a lid on inflation.
Axel Merk, president and CIO of Merk Funds, a currency fund firm, says that the trend toward a stronger renminbi is likely to continue, but he says the gain against the dollar is likely to be gradual, and so a rising RMB may not be as good a backstop for investments that perform poorly as it might have been in the past.