In addition to the headlines out of Europe, also weighing on investors’ minds these days is the economic health of China. Seemingly, not a day goes by without yet another story of how the county’s expansion is grinding to a halt. Earlier this week, for instance, it was reported that the country’s Purchasing Managers Index (PMI), an indicator of manufacturing activity, fell to 50.4 percent in May. That ended five consecutive months of growth in the index.
This is certainly something we take seriously since global growth and the commodity story are so entwined with China’s development. But we’re far more sanguine than most that China will avoid a so-called hard landing for a host of reasons, not least of which is the government’s ability to move swiftly and decisively to head off failure.
In the past, we’ve discussed how the government is offering strong incentives to move the economy away from its dependence on exports while encouraging the development of the under-utilized consumer sector. Its latest moves toward this end include fast track approvals for infrastructure investment. The government plans to accelerate projects already earmarked under the national five-year development plan with an emphasis on power plants, highways and railways.
Furthermore, China will invest more than 2 trillion yuan (about $314 billion) on previously announced energy-saving and low-carbon projects during the current Five-Year Plan period (through 2015). These projects will create new jobs, which will further stimulate the economy.
On the consumer front, the government plans to reintroduce a “cash for clunkers” subsidy aimed at rural residents. Consumers who trade in an old vehicle for a new fuel-efficient one will receive a subsidy of up to 5,000 yuan on the purchase price. The government is also expected to introduce subsidies for energy-saving home appliances this month. If experience is any guide, these moves will have a meaningful impact on the economy.
Although still a far cry from the stimulus enacted in 2008-09, remember that on a purchasing power parity basis the government’s spending represents far more than the same dollar amount would in this country.
China has other options at its disposal as well. The county has brought inflation under control. That has allowed the yuan to slip to a six-month low relative to the dollar, making its exports more competitive. If inflation were a problem for China, the country could simply allow its currency to rise relative to the dollar, immediately reducing the cost of imported materials and goods.
With inflation in check and the air let out of the real estate bubble, Chinese banks have more room to lend. Looking to foster lending, the central bank has cut bank reserve requirements three times in the past six months and just cut short-term rates by a quarter point for the first time in three years. And the central bank has plenty of room to cut rates further.
Those banks, incidentally, are in great shape: They are better capitalized than their international counterparts, with non-performing loans as a percentage of assets and total loans far below the average of their peers.
For now, the consensus among western economists is that China’s growth will slip below 8 percent this year. Certainly, further weakness in Europe won’t help China’s economy. But, as has been the case so often in the past, the consensus is likely too pessimistic with its view of what’s going on in the country. And it means expectations for commodity prices are likewise too low.
We continue to like select commodity plays to profit from China’s expansion. And we’re quite bullish on gold and gold stocks given China’s surging demand for the yellow metal. Another investment choice worth considering to profit from that country’s future is Chinese banks, which may just be the ultimate contrarian play.
Operating in a market that largely excludes foreign competition, the “Big Four,” banks account for about 40 percent of the lending in China. One of our favorites is Industrial & Commercial Bank of China (IDCBY). It’s very well capitalized and truly “too big to fail.” Trading at a single-digit price-to-earnings ratio and yielding 5.5 percent, the bank is likely to grow its profits by a low to mid-teens rate in the coming years, making in exceptionally attractive.