This is part of a four-article series discussing the outlook for and ways to invest in the BRICs countries.
The engine of global growth has been giving investors fits this year. China’s economy is slowing, but whether it’s headed for a hard landing of a soft one is still very much up for debate.
Although the short-term picture for the Middle Kingdom’s future remains opaque, there’s little question that in the longer term, China offers compelling opportunities for investors — and there’s ample ways to gain exposure.
A Slowdown — Relatively Speaking
Recent handwringing over China’s immediate prospects is well-founded. A decade of astonishing double-digit growth has led to fears of asset bubbles — particularly in real estate and construction — and inflation. Furthermore, the country’s international trade imbalance and underwhelming domestic consumption is decried by economists as untenable over the long term.
It also doesn’t help that official figures are often hard to take at face value. China’s official purchasing manager’s index (PMI), a key measure of economic activity, expanded to 53.1 for March. Meanwhile, HSBC’s own respected reading on China PMI slipped to 48.3 — indicating a contraction. These sorts of divergences in official and private data don’t instill confidence, and increase investors’ risk.
Of course when it comes to risk, investors need extra reward, making the performance of China’s stock market especially disappointing this year. The Shanghai index is up just 6% in 2012, lagging the S&P 500 by nearly 3 percentage points. That’s not up to snuff considering the Chinese economy is growing roughly four times as fast as the U.S. and Chinese markets are much more risky and volatile.
The reality is that China faces further economic slowdown as delayed policy easing carries over into the second quarter, Citigroup analysts note. Real (or inflation-adjusted) gross domestic product is seen increasing 8.4% this year — enviable, yes, but a far cry from the double-digit growth of just a few years ago.
“The first quarter saw markets turn pessimistic about Chinese growth because of weaker than expected macro data, slower than expected policy easing and after the National People’s Congress (NPC) remained cautious on the fiscal front and on easing property curbs,” Citi analysts say in a recent note to clients.
Meanwhile, with inflation running above 3%, China is unlikely to enact any interest rate cuts to boost its cooling economy, the analysts note.
But that doesn’t mean investors can throw up their hands and forgo involvement in the world’s third-largest economy (after the European Union and U.S.). Yes, China’s growth likely will continue to decelerate, but it will still average a whopping 8% a year, say analysts at Morgan Stanley.
“China is still the next big thing,” the investment bank’s China research team writes in a new report to clients. “China is poised for a ‘megatransition’ between now and 2020 — from leading producer of globally distributed goods to the world’s largest market for consumer and industrial products.”
That makes for an abundance of opportunity for investors with longer time horizons. The question, then, becomes how best to invest.
Chinese Investments
For brave stockpickers with a high tolerance for risk, scores of Chinese companies are listed on U.S. exchanges through ADRs. China Mobile (NYSE:CHL), the telecom giant, boasts a market cap of more than $215 billion on the New York Stock Exchange. Baidu (NASDAQ:BIDU), the “Google of China,” is listed on the Nasdaq with a market cap of more than $50 billion.
But assembling a portfolio of ADRs may not be the best way to go. For one thing, many Chinese ADRs suffer from low trading volumes relative to their market caps.
More important, it’s simply easier, cheaper and safer to gain diversified exposure to Chinese equities through exchange-traded funds. The iShares FTSE China 25 Index (NYSE:FXI), the biggest ETF in the category, affords exposure to Chinese mega-caps in a single tidy package. If investors want to try to capture the small-cap premium, there’s the Guggenheim China Small-Cap Index ETF (NYSE:HAO). For a focus on large-cap financials, telecom and energy stocks, the SPDR S&P China ETF (NYSE:GXC) offers ample exposure at a comparatively low cost.
However, perhaps the most attractive option for would-be China investors is to buy shares in big, well-known (and transparent) U.S. companies with outsized exposure to China’s megatransition, says Morgan Stanley. The firm’s China strategy team recently identified 16 brand-name U.S. companies best positioned to take advantage of China’s long-term economic and demographic changes.
Here’s Morgan Stanley’s top picks for China’s megatransition:
Nike (NYSE:NKE)
Wynn Resorts (NASDAQ:WYNN)
Yum Brands (NYSE:YUM)
Procter & Gamble (NYSE:PG)
Pfizer (NYSE:PFE)
Medtronic (NYSE:MDT)
Yahoo (NASDAQ:YHOO)
Apple (NASDAQ:AAPL)
Marvell (NASDAQ:MRVL)
Dow Chemical (NYSE:DOW)
Mosaic (NYSE:MOS)
General Dynamics (NYSE:GD)
Emerson Electric (NYSE:EMR)
Caterpillar (NYSE:CAT)
FedEx (NYSE:FDX)
Diana Shipping (NYSE:DSX)
The engine of global growth might be slowing, but it’s still expanding at breakneck pace, especially given the sheer size of China’s economy ($6 trillion) and population (1.347 billion). Any portfolio with exposure to emerging markets will naturally include China, indirectly or not. Fortunately, the country’s long-term opportunity remains intact — and there’s no shortage of options to play it.
Other BRICs reports:
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.
