Beware Bubbles And Malinvestment - But China Is Not Heading Off A Cliff: Invesco Perpetual

Tom Burroughes

12 May 2015

The outlook for China has its uncertainties but the picture is more complicated than what the doomsayers may suggest, according to , the investment house.

The fact that China’s once red-hot growth rate will moderate – it is currently at an annual pace of around 7 per cent – is not the same as a fall into some sort of crisis, Andy Hall, global equities fund manager at the firm, said in a recent note.

“Many investors are worried about the Chinese economy; some investors think we are approaching a ‘sub-prime’ moment for China. We see many challenges facing the world’s second largest economy but we think the outlook for China is more nuanced than the pessimists argue,” Hall said.

Hall’s comments come against a backdrop of concern that the shift by China towards a more domestically-focused, consumer-based economy, and less of an export-driven one, will bring severe pains in the forms of fissures in its financial markets and a possible hard landing for its real estate market. Among worries is the potential fate of the country’s so-called “shadow banking” system and the plethora of wealth management products sold to yield-hungry investors looking for superior returns from what they can get from state-run banks.

Chinese equities have had a relatively decent run this year; the MSCI China A 50 Index of leading shares on the mainland shows total returns (capital growth plus reinvested dividends) of more than 19.7 per cent since the start of the year. By comparison, the MSCI World Index of developed countries’ equities shows returns of 5.8 per cent.

There is, in short, no reason for panic, Hall continued.

“The key detractors from the China story are excessive credit growth in the past five years, the emergence of systemic risk (risk inherent in the entire market or in a segment of the market) in the form of its shadow banking sector, slow progress on structural reforms, an ageing population and simply the law of large numbers. China’s current growth rate of 7 per cent is the equivalent to creating an economy the size of Indonesia every single year,” Hall said.

“It is inevitable that China’s growth trajectory will continue to moderate. However this doesn’t necessarily equate to a pending crisis for China. In fact some segments of the Chinese economy could still see exceptional growth in a global context for some years to come,” he said.

Hall said that in understanding China, investors must realise that China is a “vast continent” rather than just a country, with 34 distinct provinces and 660 cities (120 of them have more than one million), with different economic drivers and each at vastly differing stages of economic and social development.

The bearish commentators tend to focus on the level of debt in the corporate and local government sectors of China but neglect to mention the strength of the household sector in China, he said.

An issue is that the Asian giant suffers from a hang-over of over-investment (especially in property) driven by the previous administrations $4 trillion reflation policy. Arguably, Hall said, there has been a serious misallocation of resources and a huge build-up of credit because of stimulatory monetary policy.

“The shadow banking system does present a systemic threat to the financial system of China and there is likely to be a large bad debt problem which the government must manage. However, we believe the Chinese administration are more than aware and have the tools to deal with it,” Hall said.