China May Have Ghost Cities But Rapid Growth Is No Apparition
China has hit targets in virtually everything central planners have ever outlined. Plenty of naysayers cite China’s purported credit-debt bubble and its supposedly overbuilt infrastructure. Often, critics like “60 Minutes” cite China’s putative ghost cities, fully built urban areas where supposedly few to no residents live. I am not alarmed by China’s so-called ghost cities, much less Chinese overbuilding or vulnerability to a crash. The fact is, China’s urbanization goal requires that it build roughly 100 cities in the next decade, vastly greater than the scant, same five “ghost cities” belittled again and again over the last decade. Of the targets, Ordos has garnered the most publicity, probably due to its size and Mongolian desert location. But two documentary filmmakers, Adam Smith and Song Ting, offer a very different and compelling assessment. Ordos “sprang to life” on the heels of a major coal discovery. That led to massive building. Really, Ordos includes two cities, one already a vibrant metropolis of 2 million residents whose average income matches that in the U.S., the second as yet small, but as the film makers suggest, starting to catch fire. Whatever overbuilding China may have done, it was simply insufficient to create an economic crisis. The IMF authored the most comprehensive report to date on Chinese over investment. China’s debts, unlike those of the U.S. and most other countries, the IMF notes, are owed to China itself. Therefore, the risks of a full-blown Chinese economic crisis remain small. The misallocation of resources does create some economic strain. The IMF calculates that these translate into a subsidy from households to large state-owned enterprises, of roughly 4% of GDP. However, if that figure is accurate, or even somewhat higher, Chinese per capita income has nevertheless grown faster, over a much longer period of time, than in any country since the advent of capitalism. In the last 13 years, by contrast, real U.S. median incomes declined about 10%. Moreover, the IMF and Western analysts in general judge investment returns along a fairly short time horizon. China probably views returns on investment in its infrastructure, especially in energy, as heavily back-loaded. Chinese academic articles predict peak coal sometime in the next decade. Clearly, the world ought to start to prepare now, although gains will not be evident until coal supplies start to lag demand. To me, this provides yet another indication that China sits on firmer ground than many believe, and that fears of a Chinese real estate bubble in particular are way overblown. Here’s a number never cited in the U.S. press, real estate price changes relative to GDP. Broad-based measures of home or property prices in China, show that gains over several years pretty much match GDP growth. During the U.S. housing bubble, by contrast, home prices increased several times faster than annual growth in GDP. Similarly, in Japan, real estate prices during the late 1980s rose many times faster than GDP growth, while P/Es on the Nikkei in the same period often rose to triple-digit levels. In China, current P/Es remain at the single-digit level. In a country as big as China one would normally expect to find pockets of overvaluation in virtually all assets, but I think China’s critics have wildly exaggerated the extent of the problem. In fact, China’s economy is no longer export driven. Retail sales and internal consumption are growing along with GDP. Since so much evidence against China is anecdotal, here is a contrasting anecdote. The current No. 2 in China’s hierarchy, Li Keqiang, also responsible for economic policy, for five years earlier worked beside former economic minister Wen Jiabo. Since his portfolio then included the entire array of economic management, arguably his knowledge of the Chinese economy is second to none. If China really faced serious economic trouble, I doubt he’d have eagerly accepted his current post. Actually, Li campaigned for it and landed in a government position even higher than that of Wen, previously No. 3 in the pecking order. To the best of my knowledge, the Chinese aren’t famous for acceptance of suicide missions. So what investments are leveraged to Chinese growth? With so many cities and so many infrastructures left to build, commodities will, as mentioned in a previous blog, naturally benefit. The biggest bang , however, could be in the Chinese stock market. A profound laggard in recent years the Chinese market could play catch-up, big time, as the government continues to liberalize its markets. The government now mostly shuts out foreigners from the vast majority of Chinese stocks. That is changing quickly as the Chinese seek an ever greater role for their currency, the Yuan, in world commerce. Gradually, the government is opening the gates to foreigners to invest directly in Chinese markets, although for the typical retail customer, pickings remain pretty slim. Here are several picks available to all investors. Industrial and Commercial Bank of China, which trades under the symbol IDCBY, is one poster child of more liberalized Chinese markets. The largest Chinese bank trades with a P/E of only 5.5 and yields over 6 percent. With such metrics the bank looks to me like a great bet that China is far from the verge of total collapse. I also like the China Fund (CHN), which probably offers the best way to get a stake in all the ultra-fast growing Chinese companies still closed to foreigners. The fund has sharply outperformed all the major Chinese stock averages. Additional plays representing China's upward mobility theme include the internet and software companies Baidu (BIDU) and NetEase (NTES), Internet retailers like travel-based Ctrip.com International (CTRP) and ECommerce China Dangdang (DANG). For those who might consider individual Chinese stocks a tad too risky, there is always the large cap iShares FTSE/Xinhua China 25 Index (FXI), an ETF that focuses on bigger state-owned businesses. Disclaimer: Dr. Leeb currently recommends China Fund to his clients.