Buy Low in China

The recent performance of the Chinese stock market is a good reminder of just how volatile emerging markets can be. The Shanghai Composite Index fell by 50% from late 2001 to late 2005. Then, in the following two years, it gained an astonishing 500% before starting its current slide.

Why are emerging markets so volatile? Much of the problem is hot money from the West looking for the next big thing. Four of the largest twenty public companies are Chinese and only the US and Japanese stock markets are worth more. However many firms such as Petrochina and China Mobile are still majority owned by the government, so lots of Western money has been chasing relatively few available shares and squeezed prices upwards as a result.

Other emerging markets have been struggled too. However, Brazil, Russia and India – together with China are hailed as new economic superpowers – have fared much better. Brazil and India are at roughly the same level they were at twelve months ago and Russia is only some 10% lower.

China’s growth is slowing a little, although it is still above 10% a year. The government has been raising interest rates to bring down inflation, while lower demand from the US for its manufactured goods is also having an effect. It seems to be working as Chinese consumer inflation has decreased by a couple of % points this year, in contrast to the experience of other countries.

Questions are increasingly being asked about the quality of China’s growth and the robustness of its lending practices have been criticised. It will become increasingly dependent on food and raw material imports in the coming years. Despite all this, China is expected to take over from the US as the world largest manufacturer next year with a 17% share. Back in 1990, it accounted for just 3%.

The key question for investors is whether the current problems are just normal growing pains or due to deeper structural faults that will prevent China being the economic superpower. Investing is a long-term game and a bet on the growth China should be seen as a 10- to 20-year play. Given that sort of timeframe, now looks like a reasonable entry point, although dripping money into the market on a regular basis will be a better strategy for most people. It’s certainly easier on the investing nerves!

Summarised based on article by Stuart J Watson | 14 August 2008