The Chinese economy has been hogging the headlines recently for the wrong reasons, with concerns globally about the state of their economy. Many economists have voiced concern about the accuracy of Chinese economic data fearing the economy could be undergoing a more dramatic slowdown than official statistics are indicating.
The slowing of the Chinese economy shouldn’t come as a surprise given the extraordinary growth we have witnessed over the last 25 years, which has averaged about 10% a year. As an economy grows bigger (remember China is now the second largest economy in the world) the harder it becomes to continue growing at a rapid pace.
Chinese GDP Growth since 1992
Source: Bloomberg data
Historically, the Chinese economy relied on investment in infrastructure and real estate as well as exports to generate economic growth. The problem for China is this “old” economic model has led to a dramatic increase in debt, over capacity in many industrial sectors such as cement and steel, property speculation and a large amount of wasted investment.
To its credit, the Chinese Government has realised that this outdated economic model is running out of steam and is not sustainable in the long run. The focus of the government now is to reposition the economy to one that generates more economic growth from consumption and services. In mature economies such as the US and UK, consumer spending represents as much as 70% of GDP.
The move to a consumption driven economy in China will be a challenge, particularly in a country where individuals are renowned for saving and not spending their earnings. Historical experience in other Asian countries, when they transitioned their economies to more consumption driven, points to a bumpier growth outlook for China. We are encouraged by the policies the Chinese Government has introduced to promote consumption, including:
- Lifting minimum wages
- Improving the social security net by introducing basic medical coverage and;
- Increasing education spending
We expect these measures overtime will stimulate consumption growth.
While we do have concerns about the outlook for the Chinese economy, on a positive note, the transition to a consumer led economy is actually taking shape. This view is backed by consumer data that we track to gauge the strength of the Chinese consumer. For example, airline passenger volumes are rising over 10% year on year and the Chinese are falling in love with the movies, with movie box office revenues up a whopping 48% in 2015. In addition, e-commerce continues to boom in China, it’s now the largest e-commerce market in the world growing over twice the pace of the US and Europe.
Our confidence in the Chinese consumer is further reinforced by recent sales figures of global multinational companies that have significant businesses in China. The following table shows Chinese sales figures for a number of well-known branded companies including Nike, Adidas, H&M, Apple and Starbucks.
Source: Bloomberg, company filings and Bernstein analysis. Note: currency neutral = removes the effect of currency fluctuations.
In general, China sales growth has been strong for these companies and in the last column on the right in the table above, you can see year on year average sales growth for the last 4 quarters. Over that period:
- Nike grew 24%,
- Adidas rose 17%,
- H&M increased over 25% and
- Apple achieved stellar growth in excess of 88%!
Starbucks doesn’t break down their China sales specifically but the company has reported sales growth in China has been faster than the Asia Pacific region which is running at over 9% growth.
These companies have attributes we look for in all our investments including strong brands, attractive products and long term growth drivers.
In summary, we remain cautious on the outlook for China in the short term given the anticipated difficult rebalancing of the Chinese economy. We expect economic growth to continue to slow as the days of 10%+ economic growth in China are well and truly in the past. There will be more ups and downs in Chinese economic growth but the move to a more sustainable growth model based on consumer spending and services is the right approach.
Over the long run, the combination of rising incomes, favourable government policy and a younger generation in China more predisposed to spend will provide opportunities for investors. The rise of the Chinese consumer remains one of the more powerful trends globally which we still believe is a multi-year event.
Disclosure of interest: Milford Funds Ltd. holds shares of Apple, Nike, Starbucks on behalf of investors.
Disclaimer: This is intended to provide general information only. It does not take into account your investment needs or personal circumstances and so is not intended to be viewed as investment or financial advice. Should you require financial advice you should always speak to an Authorised Financial Adviser.