How to invest to avoid a Chinese slowdown

By Casey Research

The financial media has been talking about a Chinese slowdown for years. It will happen someday. Where should your money be when it does?

“Anywhere but China” is a start, but it’s not enough. Since China liberalized its economy, it’s been slurping up commodities to fuel its booming economy. China’s insatiable appetite for oil, for example, has been a windfall to its vendors in the Middle East and Russia. As that extraordinary demand tapers off, China’s suppliers are in for some pain.

(Before I go any further, let me acknowledge that yes, China obfuscates its economic data, and yes, its GDP numbers are more of a public relations tool than an honest calculation of growth. Regardless, I think we can all agree that Chinese economic growth has been impressive, so let’s work under that assumption, even though we don’t know the actual numbers.)

Let’s start with where you don’t want your money to be. If you think China is slowing down, youdon’t want to invest in any of the countries whose economic fortunes depend upon exporting goods to China.

Take Chile, for example. Chile sends 24% of its exports to China. So if you expect Chinese growth to slow its (reportedly) blistering pace, you definitely don’t want to invest in Chile… especially when you consider that Chile is China’s largest supplier of copper, and copper accounts for a full 1/5 of Chile’s GDP.

The following table illustrates what percentage of each of the top twenty economies’ exports go to China. The countries with “n/a” don’t export a meaningful amount to China.

 

As you can see, 11 of the top 20 economies export a substantial amount to China. All of the big boys are on the list… the US…Japan…Germany. All of the BRICs, too, except for China itself. Pretty much all of the world’s leading economies export a meaningful amount to China.

With one major exception: Europe.

Why? The answer is simple, actually: because Europeans mostly trade amongst themselves. Spain sells to France. France sells to Germany. Germany sells to the UK. You get the idea. European trade is largely self-contained.

A little incestuous? Yes. And when Europe has internal problems, its reliance upon itself exacerbates any bad news.

But Europe’s self-reliance also insulates it from external disturbances… like a slowing China.

Of course, Europe has its own serious problems; I’m not saying you should run out and buy European stocks. Our flagship newsletter The Casey Report, which searches for investment opportunities all over the globe, has stayed far away from European investments… with the only exception being our stake in a rock-solid Nordic country that isn’t part of the EU.

What I am saying is that Europe is unique in that it is home to a number of developed economies that don’t rely on China to buy their stuff. If you’re looking for a mature market that can insulate you from exposure to China, start with select countries in Europe.

I’ll let Sara Nunnally, editor of Macro Trader, take it from here. In this original piece, Sara digs a bit deeper into slowing Chinese growth and shares a fascinating theory on why slowing growth is an unavoidable—and even desirable—outcome for a transitioning economy. Read on to find out more.

See you next week.

Dan Steinhart
Managing Editor of The Casey Report

When Slowing Growth Is a Good Thing

By Sara Nunnally, Editor, Macro Trader, Contributing Editor for Inside Investing Daily

How long have we been asking if China will have a hard or a soft landing after the Great Recession? If growth in the Far East will really dry up, or just experience a temporary blip?

Cases for both sides have been made, with pictures of empty malls and apartment buildings contrasted with massive—and much needed—infrastructure projects.

Here’s the bottom line…

Growth in China has been slowing.

But this is a good thing, and it should have been expected.

One of my favorite books on the subject is Michael Spence’s The Next Convergence: The Future of Economic Growth in a Multispeed World. In it, Spence talks about what happens when a developing economy transitions to a middle-income economy:

“Middle-income transition refers to that part of the growth process that occurs when a country’s per capita income gets into the range of $5,000-10,000. At this point, the industries that drove the growth in the early period start to become globally uncompetitive due to rising wages. These labor-intensive sectors move to lower-wage countries and are replaced by a new set of industries that are more capital-, human capital-, and knowledge-intensive in the way they create value.”

Spence says that most countries try to hold on to the old ways they’ve done business, and governments throw subsidies and tariffs at the problem in an effort to remain competitive. We’ve done that here in the US with a lot of our agricultural commodities.

Nearly all manufacturing-based economies that transitioned into modern economies experienced slowing or even halted growth for a period of time.

These growing pains are part of the process of becoming an advanced economy. Low-wage industrial manufacturing gives way to technologically advanced research and education, as well as a larger service industry that will accompany a boom in domestic consumption.

And that domestic consumption is going to be huge.

It’s a numbers game, and China’s population is still growing.

It has the largest population in the world, with more than 1.349 billion people.

Here’s how that figure breaks down:

• 0-14 years: 17.2%
• 15-24 years: 15.4%
• 25-54 years: 46.7%
• 55-64 years: 11.3%
• 65 years and over: 9.4%

The median age is 36.3 years. This is a demographic sweet spot, in which there is a high proportion of working-age people supporting a smaller pool of dependents.

Leith van Onselen, chief economist of Macro Investor, writes:

“Such an advantageous age structure has effected almost all of the world’s major economies and produced a population structure optimal to economic growth—that is, where the largest segments of the population were neither young nor old, but in the middle (i.e., working age).”

That’s just where China is sitting… right in the middle.

And this middle-income transition means there will be fewer labor-intensive jobs and more knowledge-intensive jobs. This is important because people who work in knowledge-intensive jobs live longer, contribute more to the economy, and are generally more active later in life than those who spent their working lives doing hard labor.

So as China’s population ages—and it already is, due to the country’s one-child policy—its workforce will contribute more years of employment to the economy.

That adds up to a lot of consumption. In the past two decades, 380 million Chinese people have flocked to urban areas. GDP in cities has quadrupled.

But spending is climbing even faster. From McKinsey Global Institute:

“In China, for instance, spending on dining out starts to take off at annual incomes of around $3,000 per household and, by about $9,000, is on a firm and steep upward trajectory. Spending on transport and communications starts increasing strongly as incomes reach around $6,000 per annum. The recent growth in Chinese consumer markets reflects these inflection points. Between 2004 and 2011, per capita sales of electronics and video appliances rose fourfold and clothing and shoes rose fivefold in real terms, outpacing a 3.4 times increase in per capita income during that period.”

Would you bet against those numbers? I sure wouldn’t.

I said it’s a numbers game, and it is… but it’s also all about timing. We all know that China is slowing. But how quickly and how steeply will its economy fall? There is no one answer.

China’s transition will hit manufacturing and exports first. If you’re brave enough to short China, these sectors are your best bets. At the same time, consumer-based companies and services should ramp up as GDP per capita increases.

So slow growth won’t be hitting all areas at once. You’ll have to pick and choose your battles.

But for me, I’m not going to stand in front of the demographic train that’s boosting population in China’s six megacities by 34.37 million people by 2025. That’s a jump of nearly 38.5%. In that same timeframe, GDP per capita for these megacities will jump by 134%.

Choose your battles wisely…

Happy Investing,

Sara

P.S. If there’s one thing China will need more of in the coming years, it’s energy. That’s why the US government is quietly sponsoring a massive $400 billion project along the Gulf Coast set to help countries like China, India, and Japan meet their rapidly growing energy demands. Early investors stand to reap five-figure payouts for the next 20 years and beyond. For the full details on this breaking story, simply click here.