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Why 5% economic growth in China is better than 10%
A more moderate rate of growth helps to prevent bubbles and systemic crises, and contributes to a sustainable bull marketPublished Mon, Jan 29, 2024 · 6:13 pm
2023 was another rough year for China’s economy and its stock market. This followed a tough 2022 when harsh Covid measures were abruptly lifted and the economic reopening was chaotic.
Consumers and business owners, who were not given handouts like in most countries, still seem to be suffering from “post-Covid blues”, such that the economic recovery and confidence are not as strong as many had hoped.
Chinese consumers are still hoarding excess savings in their bank accounts instead of spending. The negative wealth effect of a three-year stock market slump, along with plummeting real estate prices, also sapped spirits and fed pessimism about China’s future.
In the face of these challenges, China did not blink and resort to massive money printing. It maintained monetary discipline, which is negative for the stock market and domestic consumption in the short term. But it affords the country greater flexibility in the coming years both in terms of monetary as well as fiscal policy, should economic conditions call for more measures.
On top of domestic challenges, China also had to manage persistent geopolitical tensions with the United States, which has launched “wars” against China on four fronts – trade, semiconductor chips, investments, and propaganda. While some global investors fear that the wars of rhetoric may escalate to a hot war, any clash of arms may be rather limited, as neither power wants to risk mutually assured destruction.
Pessimists think the Thucydides Trap will take centre stage. As this theory goes, war is inevitable when a great power’s supremacy is threatened by a rising power. Some investors have also begun to discount the likelihood that China’s economy sinks into a long-term slump or Japan-style deflation, along with other ills like sustained capital flight and innovation bottlenecks.
On the bright side, China has found more support in coalescing the Brics geopolitical grouping, which comprises Brazil, Russia, India, China and South Africa. China’s breakthrough in 7-nanometre chips resulted in Huawei’s colossal comeback in 5G phones via its flagship Mate 60 smartphones.
Sustained innovations in electric vehicles (EVs) also bode well for China’s technological future. These developments illustrate China’s transition away from its fixed asset and property-driven economy, towards one that is focused on and powered by high-value-added manufacturing and innovation.
In such a transition, a long-term gross domestic product growth rate of 4 to 5 per cent is appropriate and ideal.
Yet, many economists and investors still wish for some kind of stimulus before they turn more bullish on the country. A return to 10 per cent or even 8 per cent annual GDP growth must mean the resumption of, or an increase in, China’s infrastructure spending as well as a strong credit and property market-driven recovery.
This scenario would almost certainly lead to an even larger real estate bubble down the road as well as wasteful investment in infrastructure. We already see this in Guizhou province’s beautiful, underutilised highways, and the low returns on capital on such projects.
Rather, we think a 5 per cent growth rate will result in much higher quality and sustainable growth, just like in the major successful developed countries, preventing bubbles and systemic crises, and contributing to a sustainable bull market. This is a new paradox that few investors have come to grips with.
At APS, we have worked to build an optimal portfolio of growth stocks as well as high-quality deep-value stocks. We do not just go for low price-to-earnings (PE) ratio stocks. “High-quality” means talented, competent and highly motivated company management, strong business franchises and healthy balance sheets. Focusing on such stocks allowed us to beat the relevant market indices by a respectable margin in 2023.
Growth stocks include promising, attractively priced deep-tech stocks that will power the new economy, such as a solar panel equipment maker, a cybersecurity firm, an industrial automation firm and a satellite mapping firm. Stocks of well-managed, strong business franchises are valued at only 20 to 40 times earnings, when the compounded annual growth rate of their earnings can be in the 20 to 40 per cent range for three years or longer.
Deep-value stocks include telcos, financial leasing companies and an oil and gas company, all selling at a fraction of their underlying intrinsic values, and as low as three to five times ex-cash earnings. We think these stocks can still deliver high single-digit growth rates for three years or longer, while paying annual dividend yields of 6 to 10 per cent.
We have not seen such depressed valuations and extreme pessimism since we started investing in China almost three decades ago. Barring some sort of catastrophe, we believe a rerating of these stocks must take place because their valuations are just incredibly cheap. In fact, the rerating process may have already begun.
