China, Off The Charts…Literally

A client recently asked me about China. Here is the Readers Digest version of my reply:

Let’s not kid ourselves, China is America during the industrial revolution. I’m not just talking growth; I’m talking about the lawlessness that takes the form of carelessness toward consumers, workers, and intellectual property rights. In America, we’re just older & slower now — And we’re much more sophisticated about how we screw people. 🙂

For the last 5 years, the talk has been “there’s a bubble in China.” I get it, but they are also flush with cash as the world’s factory for pretty much everything you’re going to get this Christmas. Near-term their biggest risk to growth is their ability to create a middle-class. Real estate will almost surely hit them hard at some point, but the banks seem to be well capitalized to handle it (we just need to trust their accounting). It’s going to be a bumpy ride, no doubt. But the empty cities, often cited as a go-to sign of the bubble, are for the inevitable shift of its population from the countryside to the cities. When or how cleanly that takes place is absolutely unknowable, but the move is going to happen.

From Morningstar:

Perhaps the biggest counterargument to the overbuilding thesis goes as follows: Despite the massive urbanization of the past couple of decades, China remains rural by global standards and will continue to require large additions to its capital stock as it accommodates new urbanites. According to Chinese government figures, even after an influx of 207 million new urban residents in the past decade, only 50% of the population resides in urban areas (Exhibit 5). An increase to 70% urban, a level typical of the high middle-income status to which China aspires, would add another 272 million to China’s urban total. That’s equivalent to adding 33 cities the size of New York.

The gist of Morningstar’s article is that China’s growth is unsustainable, and on it’s current trajectory that’s true– but it also doesn’t mean the whole thing comes crashing down. The chart for FXI being under the 10 month moving average doesn’t exactly having me panting to buy right now. (charts courtesy of ETFreplay, click to enlarge)

Here’s the thing though, China’s ability to develop their infrastructure in the 21st century is a unique advantage for them to become the next global powerhouse. So, as long as they haven’t been too shortsighted with regard to the quality of their construction (which is totally possible), China seems to be in an enviable position. The outcome, of course, remains to be seen because everything is still so new. At some point, I do expect China to be taken to the woodshed for all of the imbalances that exist today, but, I don’t know if it will manifest itself politically or financially, or when.

But when I look at the charts from Morningstar, all I can say right now is WOW…

Literally Off The Chart

So, What Say You?…. 

Morningstar: Investment Boom Unsustainable

Disclosure: No Position in FXI at this time. Not Investment Advice.