Measuring up China and Japan
China may have gone past Japan to become the world’s second-largest economy. Yet it is Japan where Arnout van Rijn, CIO Asia, is finding more stock-market bargains.
It made a great headline this August: the Chinese economy has overtaken the Japanese economy in terms of GDP. It has thus become the second-largest economy in the world. Only the US is bigger now.
Yet that was an inevitable development when you realise that China’s population is ten times that of Japan. What it actually means is that the average wealth of the Chinese is now just over 10% of the average Japanese. Still a long way to go!
China was a very poor country in 1980, when it embarked on its miraculous 30-year journey that has featured annual growth of nearly 10%. It is now a middle-income country. Anyone visiting Beijing or Shanghai will be deeply impressed by what has been achieved and will never view China as a poor country again.
One more milestone on the way to becoming an economic superpower
Overtaking Japan has boosted China’s confidence; it is yet another milestone on the road to becoming an economic superpower. Chinese businessmen are full of optimism. Unlike in Japan, where executives are struggling to find any growth, in China there is seemingly endless stream of upbeat companies with a strong growth outlook.
Soon the country will have to be satisfied with a slower growth rate. In China, though, that still means 5-7%. That is a mouthwatering prospect from the perspective of a European investor.
China is underrepresented in global equity indices
Does this news mean you need to invest more money in China? Not necessarily. The link between economic growth and corporate profit growth is not always a clear one. However, China has done an excellent job over the past decade of translating 10% economic growth into 26% annual profit growth.
Major global stock market indices assign a weighting of only 2% to Chinese equity. That compares with 8% for Japan and nearly 50% for the US. I believe it makes sense to invest more in line with China’s weight in global GDP. That would result in putting about 8% of an equity portfolio there. Combining the market value of stocks listed in Shanghai, Shenzhen and Hong Kong the Greater China stock market is already the world’s second largest after the United States. Its weight by this yardstick is 12%. However, few investors have access to the A-share market. Chinese equity markets are also growing very quickly in breadth.
Generally, high-growth markets are underrepresented in global equity funds. That means that investors might need to add an Asian or emerging markets fund to their portfolio to achieve adequate exposure.
There are risks in the rebalancing of the Chinese economy
There are risks, too: China is a socialist market economy. Over recent decades, a large part of the benefits from the country’s robust growth has ended up in the hands of a happy few. Now, the government wants to boost the labour share of the economy over the investment and profit share. Wages up, margins down, weaker profit growth: that’s the risk for investors.
And don’t forget the risk of high expectations. In the 1970s and 80s, Japan was the miracle of growth; one could take a university degree in Japanology. China is without doubt the growth miracle of the 1990s and 2000s. Many Westerners want their children to speak Mandarin. And just check your local book store to see how many recent publications there are on China–and how few on Japan. Buyer beware.
Neglected stocks are in Japan not in China
Investor interest clearly focuses on China. The vibrant stock markets of China and Hong Kong have already listed over 250 new companies this year for a total value of more than $70 billion. Many more offerings are on the way for the fourth quarter. In the sleepy Japanese market there have just been 13 Initial Public Offerings. Average daily turnover in the China markets is double that of the Japanese equity market.
Fortunately, we can still find many attractively priced stocks in China for our portfolio. But we can find even more in Japan. The latter market has de-rated (that is, become cheaper) for more than 20 years now. It is completely out of favour and thus offers interesting bargains for investors. The average Japanese stock trades around book value. This means investors pay nothing for the value of the future cash flow generation of companies. China stocks on average trade at 2.4 times book value, quite a premium for its growth. The Chinese price-cash-flow multiple is 9 times; Japan on this metric is 40% cheaper.
Long-term institutional investors definitely need to be invested in China, Asia’s biggest economy, and probably in a bigger way than they are today. But don’t forget to also put some money to work in Asia’s second biggest economy, Japan.
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