Shifting sands from West to the new East

The year 2009 started off on very volatile ground. 2008 was one of the worst performing market times in modern history.

Putting that aside, the markets seemed (at least in Q1 2009) to be continuing from 2008’s trends.

For the first time in a long time, we continued to see a strong correlation between most asset classes registering negative numbers right through to the end of Q1 2009.

Confidence was still extremely weak, credit was still very tight and interest rates were still on their way down.

But on the other side of the fence, China still maintains the 5.31 per cent benchmark rate, seemingly undeterred by the global backdrop.

What people have not realised is that during the first quarter of this year, China’s A Share Market index actually rose about 10 per cent. During the same time, the Dow Jones lost another 25 per cent and even the ASX 200 lost almost 15 per cent.

What was so different about China? Liquidity was the big factor in all of this. China was the only major economy in the world to maintain credit expansion. It must be noted that since 2002, China has not had a period of credit expansion of less than 10 per cent year-on-year (yoy) growth. This includes the period of SARs and the global financial crisis (GFC).

Yes, people may say China started from a low base, which is true, but with credit expansion consistent year in, year out, that base is no longer small, yet credit expansion continues.

In the first quarter of 2009, China generated $4.47tr RMB ($812 billion) in new loans. This was definitely as a result of the stimulus package launched in November. This calmed down in April/May 2009, with just over $1tr RMB ($181 billion) in new loans written, but this was to be expected, otherwise there was a risk of a credit bubble. In contrast, developed economies around the globe were going through a very serious case of credit contraction.

Credit expansion itself can go some way in assessing the investment capability of a country, and certainly China has proven itself to be a strong power in this regard.

In conjunction with the $4 trillion RMB ($720 billion) stimulus package, it has brought confidence back into consumers’ minds, which has led to recoveries in retail sales (again, it never was negative, but in fact picked up in pace) as well as reflections in the share market.

Retail sales have been registering consistently 10 per cent-plus increases yoy each month in 2009. The main reason for this has been the increasing number of consumers purchasing daily essentials. Other than this, the key outperformance sectors within retail have been beer, spirits, dairy products, appliances and especially car sales, which have now exceeded pre-crisis levels.

The other factor that has not been highlighted is the increase in domestic travel, with an increase of 19 per cent yoy (end of May 2009). This is another sector that has many years of growth to come, as consumers have more power to travel.

A lot of data and discussion has been released on this analysis of China, and this has led to a shift of the discussion from whether or not China will recover first or quickly after the GFC to whether or not China can aid and help the world as a whole through the GFC.

The simple answer is that it cannot do this directly. China is simply not large enough as yet to help the world.

At the end of the day, China (at this stage) does not compare to the GDP of the US, nor has the financial market control. The Chinese Government has taken a tough stance in regards to helping the world. It must focus on its own internal situation before being able to help others, it is that simple.

We have all realised China was not immune to the GFC and has its own structural problems to address. China was not the cause of the GFC, but as we all understand now, it was more related to the unconstrained consumption of the US citizen, and then adding greedy policies by US banks, which caused the systematic collapse in confidence, the banking system and, ultimately, equity markets.

China has started to stabilise its economy, and as a whole, the PMI (Purchasing Managers Index) has always been the best indicator for economic activity with the past five months (ending June 2009) above 50 reflecting an expansionary phase for the economy.

In contrast to this, the US has encountered severe headwinds still registering above 50 since January 2008, with January 2009 hitting its lowest point of 32.9 and in June 2009, still only reaching 44.8.

So what is evident on both sides of the fence is that the Chinese consumer is at the heart of the Chinese recovery.

The provincial governments are certainly in agreement on this issue. In mid-June, government officials attended the five-day Pan Pearl River Delta regional economic forum and unanimously agreed to create closer ties between each province to further generate prosperity for the Chinese people. This is certainly a step in the right direction.

The other point to note here is that the representatives at this forum were mainly from the interior provinces and with such united strength to generate wealth, over time the income discrepancies between the coastal and interior cities will decrease, an issue China needs to address in the medium term.

As of late November 2008, the Chinese Government launched the most powerful stimulus package in modern history, which did not involve cash payments or subsidies but rather land reform.

Since the communist revolution in the 1950s, land rights were taken over by the state and all land was declared to belong to everyone through the state. Since then, the farmers of China have only had the opportunity to work off the land, and receive income from whatever they produce off the land.

About a decade ago, urban areas started to receive land rights where they could develop, but rural areas were left out. Now, the farmers have the same benefits bestowed upon them, which effectively allows them to sell, unlock equity (eg, home equity investment loans or equivalents) and lease to others to receive rent.

So what are the consequences to this program?

Simply put, it just created 240 million new consumers (80 million farmer families x three per family).

The central government’s move to create a larger middle class by 2020 has been propelled forward with the land reform program.

Two other consequences that many have overlooked is the development potential for real estate companies in the coming years.

Because land rights can be sold off to developers, it benefits both the farmer (who in turn can move into other cities) and developers can create more metropolises as they have been in more heavily populated urban regions.

The other is, with the creation of another 240 million consumers, FDI will likely to start accelerating into the future when companies in other countries realise how they can benefit from the rise of China. I’m referring to global brands such as Nestle, Mercedes Benz and Coca Cola, which may like a piece of the action that is about to unfold in the coming decades.

And in a nutshell, that is exactly how China is going to aid the global economy back on its feet, with its citizens speaking with their hip pocket.

The Chinese dragon is gearing up for full flight.

Jonathan Wu is head of distribution and operations at Premium China Funds Management.