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Harmony strikes a chord

Ben Yearsley

I have to admit to feeling rather sceptical on the Chinese growth story in recent times. The long-term investment prospects remain excellent but I was unsure whether it had been overhyped in the short term – and whether rapid economic growth actually means good returns for investors. A recent visit to Hong Kong with Neptune Investment Management therefore came at an opportune time to re-evaluate my views.

One of the keys themes in China’s latest five-year plan is to create a harmonious society. This may seem an obvious ambition but it would involve a massive shift in Chinese attitudes to achieve it, beginning with wage inflation. There is a big disparity between incomes in the industrial east of China and the more rural west. The dramatic difference in living standards between the two areas has prompted officials in Beijing to dispatch trade unionists to the west to help ensure they are getting a better deal.

The result is wage inflation, which, coupled with rising commodity prices, eventually translates to core inflation or rising prices of everyday goods. For us, it means higher prices for everything we import from China but for the Chinese themselves, many see wage inflation as a good thing. Increased wages should mean better standards of living and disposable income, helping rebalance the economy away from exports and construction and towards consumer spending.

As far as consumer goods are concerned, it was abundantly clear on my visit that many Chinese aspire to luxury. Watches, cars or fine wines – you name it. And not the fake goods bought by many Westerners, the wealthy Chinese demand the genuine article. Many of the luxury brands favoured are European. Fine wines are French, watches are Swiss and cars are German.

It is therefore possible to benefit from increasing consumption in China by owning good quality businesses based here in the West.

There are many fund managers who have been taking advantage of this theme in recent years and it is a significant trend that surely has further to run.

China’s property market is also fascinating. There are properties commanding huge rental prices in Hong Kong and yet you hear of numerous skyscrapers and residential blocks lying vacant on the mainland. The disparity among the property market is a worry for investors, especially if buildings are being constructed simply to keep the workforce occupied. Who is exposed to the risk that these properties cannot be rented out and to what extent?

This is certainly a concern surrounding investing in Chinese banks, which are notoriously difficult to analyse due to a lack of transparency. We do know, however, that banks are setting aside provisions against bad debts from their substantial profits. In other words, they are putting money by for a rainy day – something the West failed to do effectively before the financial crisis in 2008.

Overall, I am now far more positive on the long-term potential of China. There will be volatility along the way, not least because the Chinese themselves regard the stockmarket as something of a casino, but the sheer numbers involved are mind-blowing. Whether it is the increase in gambling revenues in Macau this year equalling an entire year’s gambling revenue in Las Vegas or the biggest-selling beer brand in the world (Snow) being one we have barely heard of in the West, the opportunities are incredible.

There are risks alongside the opportunities. China remains a communist country and one thing you cannot escape from is the possibility of political interference. There is also the shorter-term danger that rising inflation in China will rattle markets as investors worry about a slowdown in economic growth. If this happens, as it already has to an extent throughout the beginning of this year, investors could be presented with a compelling buying opportunity into this long-term story. In any case, I am planning to increase my weighting very shortly.

Ben Yearsley is investment manager at Hargreaves Lansdown

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