Download AFTER THE FALL: The Path Forward for China’s Economy

AFTER THE FALL:
The Path Forward for
China’s Economy
and Stock Market
Matthews Asia I October 2015
The subject matter contained herein has been derived from several sources
believed to be reliable and accurate at the time of compilation, but no
representation or warranty (express or implied) is made as to the accuracy or
completeness of this information. Matthews International Capital Management,
LLC does not accept any liability for losses either direct or consequential caused
by the use of this information.
The views and information discussed in this presentation are as of the date of
presentation, are subject to change and may not reflect the presenter’s current
views. The views expressed represent an assessment of market conditions at a
specific point in time, are opinions only and should not be relied upon as
investment advice regarding a particular investment or markets in general. Such
information does not constitute a recommendation to buy or sell specific
securities or investment vehicles.
Investing in international and emerging markets may involve additional risks,
such as social and political instability, market illiquidity, exchange-rate
fluctuations, a high level of volatility and limited regulation. In addition, singlecountry and sector strategies may be subject to a higher degree of market risk
than diversified strategies because of concentration in a specific industry, sector
or geographic location. Investing in small- and mid-size companies is more risky
than investing in large companies as they may be more volatile and less liquid
than large companies.
© 2015 Matthews International Capital Management, LLC PT448_1015
1
Perpetual Forecasts of Doom and Destruction
What mistakes have led so many analysts to predict imminent collapse for so many years?
1998
2001
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2
A-Shares Down Sharply, but a ‘Crash?’
 SHCOMP down 34% from June 12 peak; but up 5% YTD and up 44% YoY (as of 19 October)
 Margin trading balance down 57% from peak to US$150BN
SHANGHAI COMPOSITE INDEX
MARGIN TRADE (Rmb BN)
12%
2,500
6,000
5,000
10%
2,000
4,000
8%
1,500
6%
3,000
1,000
4%
2,000
500
1,000
0
Aug-13
Mar-14
Sep-14
Mar-15
Oct-15
2%
0
Jan-13
0%
Sep-13
May-14
Jan-15
Oct-15
Outstanding balance of margin trade (LHS)
Margin trade outstanding as a share of total market cap
as a share of market cap of free float shares
as a share of free-float shares market cap defined by Bloomberg
Sources: CEIC, Bloomberg
© 2015 Matthews International Capital Management, LLC PT448_1015
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Chinese Consumers Shrug Off A-share Correction
 50m active investors = 7% of urban population
 73% of active accounts have less than US$15,000; less than 1% have more than US$1MN
 As the market rose (March-May 2015), bank deposits increased 10% YoY. Real retail sales rose 10.8% in September same
as a year ago. Chinese tourist arrivals in Japan up 133% YoY in August
REAL GROWTH RATE OF RETAIL SALES (YEAR-ON-YEAR)
18%
16%
14%
12%
10%
8%
6%
4%
2%
0%
Jan-10
Oct-10
Aug-11
Jun-12
Apr-13
Jan-14
Nov-14
Sep-15
Source: CEIC
© 2015 Matthews International Capital Management, LLC PT448_1015
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The World’s Best Consumption Story
Year-on-Year changes in some consumer categories
133%
Chinese visitor arrivals in Japan
August
112%
Apple’s greater China revenue
3Q 2015
76%
Spending by Chinese at tax-free shops in Europe
August
59%
SUV sales
September
56%
Express parcel deliveries
September
54%
Movie box office revenue
2Q 2015
30%
Nike sales in Greater China
Three months ending August
19%
Furniture sales
September
14%
Gasoline consumption
August
11%
Household appliance and electronics sales
September
11%
Inflation-adjusted retail sales
September
9%
New home sales
September
3%
Passenger car sales
September
As of October 19, 2015, accounts managed by Matthews Asia did not hold positions in Apple Inc., or NIKE Inc.
Sources: Japan National Tourist Office; Company Data; Global Blue; CEIC; CNBC; National Bureau of Statistics of China
© 2015 Matthews International Capital Management, LLC PT448_1015
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Chinese Home Buyers Shrug Off A-share Correction
New home sales up 18% in June, 21% in July, 16% in August, 9% in Sep vs -12% in Sep 2014
YOY GROWTH RATE OF NEW HOME SALES BY SQUARE METER
60%
50%
40%
30%
20%
10%
0%
-10%
-20%
Jan-10
Dec-10
Nov-11
Nov-12
Oct-13
Sep-14
Sep-15
Source: CEIC
© 2015 Matthews International Capital Management, LLC PT448_1015
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A Serious Devaluation?
The RMB has given back 2% against the U.S. dollar (as of 16 October 2015)
RMB/USD
6.1
6.2
6.3
6.4
Depreciation
6.5
17-Jul
24-Jul
31-Jul
7-Aug
14-Aug
21-Aug
28-Aug
4-Sep
11-Sep
18-Sep
25-Sep
2-Oct
9-Oct
16-Oct
Source: CEIC
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Devaluation in Context
Since July 2005, RMB has appreciated by 30% against USD as of Oct 19th; NEER has appreciated by 46%, and
REER has appreciated by 57% as of September 2015
PBOC MID PRICE
EFFECTIVE EXCHANGE RATE
RMB/USD
2010=100
5.0
140
5.5
130
120
6.0
110
6.5
100
7.0
90
7.5
80
8.0
70
8.5
9.0
Jan-05
60
Jan-05
Mar-07
Apr-09
Jun-11
Aug-13
Oct-15
Feb-07
Apr-09
May-11
Jul-13
Nominal effective exchange rate
Real effective exchange rate
Sep-15
Nominal EERs are calculated as geometric weighted averages of bilateral exchange rates. Real EERs are the same weighted averages of bilateral
exchange rates adjusted by relative consumer prices. The weighting pattern is time-varying, and the most recent weights are based on trade in 2008-10.
Source: CEIC
© 2015 Matthews International Capital Management, LLC PT448_1015
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Devaluation was Not About Export Competitiveness
 In first six months of 2015, world exports down 10.7% YoY; Germany -12.9%;China’s +0.7%
 Despite strong REER appreciation of the RMB, China’s share of world exports rose from 11.6% in 2011 to 14.3% in June
2015. From 2001-2014, CAGR of global exports +9%, China exports +18.2%
YOY GROWTH RATE OF REAL EFFECTIVE EXCHANGE RATE
20%
MARKET SHARE OF WORLD EXPORTS
18%
15%
16%
10%
14%
5%
12%
0%
10%
-5%
8%
-10%
-15%
Jan-06
Mar-09
China
May-12
Germany
Aug-15
6%
Jan-06 May-07 Sep-08 Feb-10 Jun-11 Oct-12 Mar-14 Jul-15
China
Germany
Source: CEIC, WTO
© 2015 Matthews International Capital Management, LLC PT448_1015
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China has Been the U.S.’ Fastest Growing Export Market . . . by Far
Growth rate of U.S. exports to its 10 biggest market, since China joined the WTO in 2001
Brazil
177%
Canada
74%
Mexico
116%
China
666%
Japan
3%
Germany
68%
UK
30%
Netherlands
100%
HK
180%
S.Korea
60%
Total US exports minus
China
97%
0%
100%
200%
300%
400%
500%
600%
700%
Source: CEIC
© 2015 Matthews International Capital Management, LLC PT448_1015
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Not Deleveraging, but Steadily Slower Credit Growth
YoY
40%
35%
30%
25%
20%
15%
10%
5%
0%
2002
2003
2004
2005
2006
Outstanding TSF
2007
2008
2009
Rmb loans outstanding
2010
2011
Nominal GDP
2012
2013
2014
3Q15
M2
TSF=Total Social Finance, or aggregate credit.
Sources: CEIC, People’s Bank of China
© 2015 Matthews International Capital Management, LLC PT448_1015
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The Party’s Top 5 Mistakes
 Putting the Party above the law
 Lack of trusted institutions, and inhibiting the development of civil society
 Blocking freedom of expression and political dissent
 Slow to fix China’s environmental disaster
 Overly aggressive approach to neighbors in the South and East China seas
© 2015 Matthews International Capital Management, LLC PT448_1015
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Mistake 1: Underestimating the Dominant Role of the Private Sector
Millions
450
400
350
300
250
200
150
100
50
State-controlled urban employment
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
0
Private urban employment
Source: CEIC Data
© 2015 Matthews International Capital Management, LLC PT448_1015
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Not Surprisingly, Private More Profitable
 Profits for privately-owned industrials were up 13% YoY in August, the eighth consecutive month of profit growth
 In contrast, state-owned enterprise (SOE) industrial profits were down 44% in August, the 13th consecutive month of
declining profitability
 Privately-owned industrial firms now account for 35% of total profits of larger industrial firms, up from a 12% share a
decade ago
YoY
40%
30%
20%
10%
0%
-10%
-20%
-30%
-40%
-50%
Jan-12
Sep-12
Jun-13
Profits by SOEs
Feb-14
Nov-14
Aug-15
Profits by private firms
Source: CEIC, MICM estimates
© 2015 Matthews International Capital Management, LLC PT448_1015
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Most Bank Loans Now to Private Firms
STOCK OF BANK LOANS
Share
50%
Private Sector
40%
30%
State-Owned Enterprises
20%
Consumer and Mortgage Loans
10%
Government and Public Institutions
0%
2006
2007
2008
2009
2010
2011
2012
2013
Sources: People’s Bank of China, CEIC, MICM estimates
© 2015 Matthews International Capital Management, LLC PT448_1015
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Mistake 2: Not Recognizing that Rebalancing is Well Underway
Percentage Points
16%
16
14
14%
12
12%
10
8
10%
6
8%
4
6%
2
0
4%
-2
2%
-4
0%
-6
Final Consumption
Gross Capital Formation
Net Exports of Goods and Services
GDP Growth Rate, YoY (RHS)
*Estimates
Source: CEIC, MICM estimates
© 2015 Matthews International Capital Management, LLC PT448_1015
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Services Now More Important than Manufacturing and Construction
SHARE OF GDP BY PRODUCTION APPROACH
Share of GDP
60%
50%
40%
30%
20%
10%
0%
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
3Q15
Primary industry refers to agriculture, forestry, animal husbandry and fishery and services in support of these industries
Secondary industry refers to mining and quarrying, manufacturing, production and supply of electricity, water and gas, and construction
Tertiary industry refers to all other economic activities not included in the primary or secondary industries, including real estate, finance,
wholesale and retail, transportation and other service industries
Source: CEIC
© 2015 Matthews International Capital Management, LLC PT448_1015
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Mistake 3: Underestimating Chinese Consumers
Real compound annual growth rate of final consumption from 2009 to 2014
China
Germany
United Kingdom
8.7%
1.1%
1.0%
India
Japan
7.2%
1.3%
Korea, Rep.
2.7%
HK
5.0%
Thailand
United States
3.0%
1.6%
Sources: World Bank, International Monetary Fund (IMF) estimates
© 2015 Matthews International Capital Management, LLC PT448_1015
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Real Growth Rate of Per Capita Household Income
YoY
12%
10%
8%
6%
4%
2%
0%
2005
2006
2007
2008
2009
2010
2011
-2%
2012
2013
2014
Average
from2005
to 2014
-4%
-6%
US
China
HK
Sources: CEIC, St. Louis Fed
© 2015 Matthews International Capital Management, LLC PT448_1015
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Consumer Spending Backed by Big Savings, Not Debt
Household savings greater than combined GDP of Brazil, India, Russia and Italy
China's Bank Deposits
by August 2015
Household Deposits
GDP
2014
Brazil
0
India
Russia
5,000
Deposits of NonFinancial
Enterprises
Deposits
Government of NonDeposits Banking
FI*
Russian Federation
Italy
10,000
15,000
20,000
25,000
US$ BN
*FI=Financial Institutions
Source: CEIC, World Bank
© 2015 Matthews International Capital Management, LLC PT448_1015
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Rebalancing Means Slower Growth is Inevitable, but Remember the Base
RMB BN
8,000
7,000
12%
10.1%
10%
6,000
8%
7.3%
5,000
6%
4,000
5.0%
3,000
4%
2,000
2%
1,000
0%
0
2004
2014
Incremental Increase in Nominal GDP
2020E*
Real GDP Growth Rate (RHS)
*2020 MICM Estimate
Source: CEIC
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Steady Wage Growth Signals a Healthy Job Market
WAGE GROWTH OF UNSKILLED FACTORY WORKERS AND SKILLED MANAGERIAL WORKERS*
YoY
20%
15%
10%
5%
0%
-5%
3Q07
1Q08
3Q08
1Q09
3Q09
1Q10
3Q10
1Q11
3Q11
Unskilled factory workers
1Q12
3Q12
1Q13
3Q13
1Q14
3Q14
1Q15
3Q15
Skilled/managerial workers
MIGRANT WORKER INCOME
YoY
RMB per capita
4,000
25%
3,000
20%
15%
2,000
10%
1,000
5%
0
0%
Mar-09
Sep-09
Sep-10
Mar-11
Sep-11
Mar-12
Sep-12
Average Monthly Income of Migrant Worker (LHS)
Mar-13
Sep-13
Mar-14
Sep-14
Mar-15
Sep-15
Growth rate (RHS)
*Surveys for the 4Q11 and 1Q12 time periods were not conducted.
Sources: CLSA, CEIC
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Regional Variations in China’s Growth Story
Resource extraction and heavy industry concentrated in the northeast
1H 2015 GDP GROWTH RATE BY PROVINCE
Source: CEIC
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Mistake 4: Misunderstanding “Shadow” Banking and Debt Problems
Most “shadow” credit is from party-controlled institutions
100%
90%
80%
70%
60%
50%
40%
30%
Other
20%
Banker’s Acceptance Bills
Trust Loans
10%
Entrusted Loans
2002
2003
2004
Rmb New Loans
2005
2006
2007
Foreign Currency Loans
2008
2009
2010
Enterprise Bonds
2011
2012
2013
2014
Shadow
Banking
0%
1H15
Stock Financing by Non-financial Institutions
Sources: CEIC, MICM estimates
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Party Control—Regulators Applied Brakes to Trust Lending
Growth rate of new trust loans slowed to -84% YoY through Sept 2015 from +532% in 2012
RMB BN
YoY
2,000
600%
1,800
500%
1,600
400%
1,400
300%
1,200
1,000
200%
800
100%
600
0%
400
-100%
200
0
-200%
2012
2013
Trust loans
2014
3Q15
Growth Rate (RHS)
Source: CEIC
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Debt is Concentrated Among State-Owned Enterprises (SOEs)
DEBT-TO-ASSET RATIO BY OWNERSHIP
70%
65%
60%
SOEs
55%
Private Firms
50%
45%
40%
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
Source: Hong Kong Institute for Monetary Research
© 2015 Matthews International Capital Management, LLC PT448_1015
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Mistake 5: Misunderstanding China’s Property Market
90% of new home buyers are owner-occupiers, who use a lot of cash
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
Sep-07
2Q10
Feb-11
Aug-11
Mar-12
Sep-12
First-time buyers
Mar-13
Upgraders
Sep-13
Mar-14
Sep-14
Mar-15
Sep-15
Investors
Source: CLSA
© 2015 Matthews International Capital Management, LLC PT448_1015
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New home sales past peak but still healthy
NEW HOME SALES BY SQM
YoY
50%
45.4
40%
33.4
30%
20%
27.5
25.6
20.3
26.5
24.8
22.9
18.9
17.5
11.8
8.3
10%
8.2
3.4
10.0
3.0
2
0%
-10%
-20%
-9.1
-15.5
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 3Q15 01-07*08-10*11-14*
Growth Rate of Residential Floor Space Sold
*CAGR = Compound Annual Growth Rate
Sources: CEIC, CLSA, MICM estimates
© 2015 Matthews International Capital Management, LLC PT448_1015
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New Home Prices Softer, but Far from Collapse
CLSA NEW HOME PRICES, MoM
4%
2%
0%
-2%
Nov-07
Feb-09
Jun-10
Oct-11
Overall
Tier-2
Feb-13
May-14
Sep-15
Tier-3
CLSA NEW HOME PRICES, YoY
40%
30%
20%
10%
0%
-10%
Nov-07
Jun-09
Dec-10
Overall
Jul-12
Tier-2
Feb-14
Sep-15
Tier-3
Tier 1 cities: include Beijing, Shanghai, Guangzhou and Shenzhen
Tier 2 cities: include provincial capital cities, plus Dalian, Qingdao, Ningbo and Xiamen
Tier 3 cities: all other cities not included in Tier 1 and Tier 2
Source: CLSA
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More than 150 Cities with a Population of One Million Plus
Last year, more new homes sold in Hefei than in Beijing. More in Chengdu than in Shanghai
Source: CLSA
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Ghostly, or a Different Business Model?
Photos on left from cbsnews.com. Photos on right by MICM. Upper right photo taken in same location as upper left. Lower right
photo is not the same location as lower left, but is illustrative of traffic conditions observed in Zhengdong in February 2015.
© 2015 Matthews International Capital Management, LLC PT448_1015
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China Will Continue to Drive Global Growth
Contribution to Global Growth (percentage points)
6.000
5.000
4.000
3.000
2.000
1.000
0.000
-1.000
-2.000
2000
2001
China
2002
2003
2004
United States
2005
Japan
2006
2007
2008
European Union
2009
2010
2011
Rest of World
2012
2013
2014
World
Sources: IMF, World Economic Outlook (April 2014); IMF staff calculations
© 2015 Matthews International Capital Management, LLC PT448_1015
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End of China’s One-Child Policy
Politically important, but no change to demographic trends
Births per Woman
6
1980: Enforcement of
China’s one-child policy
5
4
3
2
1
0
1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
China
Japan
Indonesia
South Korea
Thailand
Source: World Bank
© 2015 Matthews International Capital Management, LLC PT448_1015
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Active vs. Passive for China
Market cap of MSCI China by sector and ownership
BY SECTOR
Other
28%
Food,
Beverage and
Tobacco 3%
Consumer Staples 1%
Financials,
Telecom Services,
Capital Goods,
Energy, Utilities
and Materials
67%
BY OWNERSHIP
Private
Firms
29%
SOEs
71%
Consumer Durables
and Apparel 1%
The MSCI China Index is a free float–adjusted market capitalization–weighted index of Chinese equities
that include China-affiliated corporations and H shares listed on the Hong Kong exchange, and B shares
listed on the Shanghai and Shenzhen exchanges. It is not possible to invest directly in an index.
Source: CLSA; data as of November 26, 2014
© 2015 Matthews International Capital Management, LLC PT448_1015
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How We Deal With This at Matthews Asia
Exposure to sectors benefiting from secular trends
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
China
Services
China Dividend
Consumer
China Small Companies
Health Care
Finance
Matthews Aggregate
Portfolio*
Manufacturing
Asia**
Commodities
*Consists of Matthews’ 15 strategies, not including the ESG Strategy which incepted April 30, 2015.
**Asia is a market cap weighted universe as defined by FactSet’s geographic classification.
Sector exposures of largest account in each strategy. Sources: FactSet, MICM; Data as of May 12, 2015
© 2015 Matthews International Capital Management, LLC PT448_1015
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Today’s Speaker
ANDY ROTHMAN
Investment Strategist
Andy Rothman is an Investment Strategist at Matthews Asia. He is principally responsible for developing research focused
on China’s ongoing economic and political developments while also complementing the broader investment team with
in-depth analysis on Asia. In addition, Andy plays a key role in communicating to clients and the media the firm’s
perspectives and latest insights into China and the greater Asia region. Prior to joining Matthews in 2014, Andy spent 14
years as CLSA’s China macroeconomic strategist where he conducted analysis into China and delivered his insights to
their clients. Previously, Andy spent 17 years in the U.S. Foreign Service, with a diplomatic career focused on China,
including as head of the macroeconomics and domestic policy office of the U.S. embassy in Beijing. In total, Andy has
lived and worked in China for more than 20 years. He earned an M.A. in public administration from the Lyndon B.
Johnson School of Public Affairs and a B.A. from Colgate University. He is a proficient Mandarin speaker.
© 2015 Matthews International Capital Management, LLC PT448_1015
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