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Looking Past Near-Term Difficulties in China

China has quickly gone from hero to scapegoat of the global economy, bearing the blame for the sharpest sell-off in stocks in the last three years. The policy actions taken by Chinese leaders over the last several months, highlighted by the decision to devalue its currency, have called into question their ability to manage the country’s growth rate and stanch a selloff in Chinese shares. This apparent lack of control has soured investors on China and the many asset classes it impacts.

While GDP Growth Is Flagging…

The sheer size of its economy—the second largest behind the U.S.—makes China the world’s largest buyer of commodities like copper, oil and coal. For several decades, China’s economy grew annually at a double-digit pace as measured by gross domestic product, the aggregate value of all goods and services produced by an economy. Growth was fueled by massive investment in manufacturing, the building of cities and transportation infrastructure, and a boom in exports. But in the race to become an economic superpower, the Chinese overbuilt and the country is now burdened by debt levels twice the size of its economy.[1]

The sputtering of Chinese growth has broad ramifications. The cratering of Chinese stocks—after rising over 100% in the first five months of the year—has caused the MSCI All Country World Index, a broad measure of global stocks, to surrender its gains for the year. Emerging markets, of which China is the largest, have seen their currencies decline to the lowest levels since 2010. Heightened fears of a slowdown in global growth, meanwhile, have sent commodities like copper and crude oil—the building blocks of development—to 13-year lows.[2] Growth concerns are exacerbated by the transition of the Chinese economy from a production base to a consumption base that will require the use of less raw material. Exporters of natural resources in South America, Africa and parts of Asia are most severely impacted by this shift.

…Consumer Spending Is Improving

Seeking new and more consistent sources of growth, China is transforming into a demand-oriented economy, more like the U.S., with an emphasis on services and a reliance on consumer spending rather than government investment. The country is launching its own consumer companies such as e-commerce firm Alibaba to compete with the likes of Google, Nike and Ford.

The good news is that this part of the Chinese economy is thriving, with retail sales in July increasing 10.5% over the same period a year ago. An emerging middle class of consumers, which currently represents over half of the nation’s 256 million urban households, will drive increased spending for years to come.  A cohort of Chinese consumers considered upper middle class based on income is expected to quadruple in size by 2022 and increase spending at a robust 22.4% per year over this period.[3] Such a burgeoning universe of buyers represents an attractive market for U.S. and global consumer companies. In fact, Apple and Gap are among the companies that have recently identified China as a source of growth in an otherwise tepid global economy.

The bad news is that current sentiment suggests things will only get worse in China. Many investors will try to avoid exposure, at least for the time being. Still, other investors remain optimistic that the nation’s long-term promise remains intact.

Risk-tolerant investors looking for exposure to China’s long-term growth potential may consider multinational consumer stocks that do business in China. Another way to invest in China is through Folio’s China Select RTG, a basket of securities designed to track the Bank of New York Mellon China Select ADR Index, which tracks Chinese companies listed on U.S. exchanges.

[1] Wall Street Journal. “The World Struggles to Adjust to China’s ‘New Normal’.” 8/25/2015

[2] Bloomberg. “These Charts Show How Hard China Has Hit Global Markets.” 8/21/2015

[3] McKinsey & Company. “Mapping China’s Middle Class.” McKinsey Quarterly June 2013.

 

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