Transcript: China real estate troubles are sign of strength, not weakness
- October 26, 2021 October 26, 2021
Welcome to Soundbites – weekly insights on market trends, and investment strategies, brought to you by Investment Executive, and powered by Canada Life.
For today’s soundbites, we speak about investing in China with Ross Cameron, portfolio manager with Northcape Capital. We talked about the risks and opportunities, and what names and sectors he’s bullish on. And we started with how he views the recent real estate drama.
Ross Cameron (RC): China has a closed capital account, which means there are limited investment opportunities for the wealthy coastal elite in China. So, the wealthy Chinese elite have been investing in property, and that has resulted in an overbuild of apartments in China. This is bad from a resource allocation perspective. It’s bad from an economic perspective. And so, [Chinese President] Xi Jinping wants to end that era. This is all part of this broad Common Prosperity theme [the state goal of narrowing the wealth gap]. The narrative in the media currently is, ‘Is Beijing strong enough to bail out Evergrande [Evergrande Group, based in Shenzhen, China] and the property developers?’ That’s exactly backwards. The question really is, ‘Is Beijing strong enough to let these property developers fail?’ Because Beijing really wants to send the message that, yes, property developers can fail in China. This is not just a safe place to put capital, resulting in this massive overbuild and the famous ghost cities in China.
On the powerful communist government and its influence on the markets.
RC: Xi Jinping represents a profound change for China. Xi Jinping is the strongest leader that we’ve seen since Mao. He is president for life. And so, instead of the previous leadership which was looking at GDP on a quarter-to-quarter basis, and was probably afraid to make profound economic changes, Xi Jinping is much more willing to accept near-term pain for what he sees as necessary long-term benefit. China’s economy has become very unbalanced. There is too much credit. There is poor allocation of capital. This is the reason that Chinese equities have been weak. Even though the economy is strong, if you look on a 10-year view, Chinese equities have really gone nowhere. It’s because of inefficient allocation of capital. I think Beijing wants to change that. It wants to send the message that projects that don’t make economic sense will fail. The government is not going to bail them out and that’s going to be painful over the next six to 12 months, but it actually creates a more positive landscape on a three- to five-year view and beyond.
What names he likes.
RC: It is certainly our bias currently to play Chinese consumption with two characteristics. First is luxury brand-name goods. These are exposed under Common Prosperity. That conspicuous consumption is going to become very unfashionable. Having said that, there are other elements of consumption that will benefit, and one obvious one is cosmetics. High-end cosmetics is a form of luxury consumption that is not conspicuous. China stands out for being very low in their spend on cosmetics. But we think this is just a case of catch up. So, we have LG Household & Health Care [based in Seoul, South Korea] in the portfolio, a Korean company that has the number one high-end cosmetics brand in China. It continues to grow at 20-30% per annum and China has, we think, more than 10 years of strong cosmetics growth ahead of it. And even at that level it will still be below global average cosmetics spend. The second area is select exporters. We own a Chinese plastic injection molding machine company, Haitian [Haitian International Holdings Limited]. They have some of the best machines for making plastics and, importantly, this is not a Chinese domestic play that has been propped up and supported by Beijing, but rather a true global winner. It competes against companies in Germany and Japan, and has a very significant export business.
And finally, what’s the key takeaway?
RC: Well, we can’t ignore China. In terms of the stock opportunities in China, it is very liquid. I think that the best way to play the profound and very attractive opportunities within China is through a global EM [emerging market] framework. Even though some of the headlines will be negative, and there will be casualties, it’s very important not to write off China. There is a vast market here, a huge investable universe for highly selective stock pickers.
Well, those are today’s Soundbites, brought to you by Investment Executive, and powered by Canada Life. Our thanks again to Ross Cameron of Northcape Capital.
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