Why I Believe in the Chinese Miracle

Headlines about China's economy are generally singing dirges these days:

  • "Factory Slump Puts China on Verge of Recession"
  • "China's Economic Certitude Crumbles"
  • "China Shares Drop as Economic Woes Deepen"
  • "China: Not a Financial but an Economic Crisis"
  • "China's Economy Has Conditions to Maintain Steady and Relatively Rapid Growth"

I'll bet you can't guess which article comes from the Peoples' Daily.

Yes, things are bad
China currently faces internal strife, a growing disparity between the rich and poor, overbuilding, environmental crises, inflation, a collapsed stock market, bad milk, and a dramatic decrease in the amount of time citizens can spend in Macau, all of which clearly fall under the category of things that are "not awesome."

Things are so bad in China that its gross domestic product growth rate may fall from double digits to the dowdy level of 8%. Eight percent, by the way, is a level at which the United States is unlikely to ever grow again. It can't. Our economy is simply fully developed. Thus the sobriquet "developed economy." I know, not exactly catchy.

China, on the other hand, has returned to world prominence through a 30-year economic boom whose speed and breadth is unparalleled in the history of mankind. China went from global economic irrelevance in 1980 to the country to which the United States is most vulnerable during this economic crisis, for the small reason that China holds $580 billion in U.S. Treasuries.

An American economic slowdown will hurt China, but a Chinese economic slowdown will similarly hurt the United States, since China is the third-largest destination of American exports, at more than $60 billion in the past 12 months.

But that means things are good … for investors
It's easy to be gloomy about prospects in China. Its stock market is down nearly 70% on the year, factories are closing, and its housing market is a shambles.

But did you catch that first part? The Chinese stock market is down more than 70%.

As part of our Motley Fool Global Gains investment service, we've taken a few trips to China now to see its economic development firsthand. Last year we came back intrigued, but this summer we came back excited -- because the market had dropped and there was a lot more value available.

Since then, China's market has been priced as if it will never grow again. Right now you can buy fantastic Chinese companies such as China Mobile (NYSE: CHL  ) , Guangshen Railway (NYSE: GSH  ) , and Xinyuan Real Estate (NYSE: XIN  ) as if they will show no growth for years to come. And that's just crazy.

What the market is missing is that the seeds of the current downturn in China were sown by the rapid growth it enjoyed over the past decade. There has never been a rapid growth story, ever, that didn't include some turbulence. It happened during the United States' Industrial Revolution, it happened with Japan -- heck, it happened with McDonald's (NYSE: MCD  ) and Cisco (Nasdaq: CSCO  ) .

All of the headlines show China sitting at a crossroads. But the reason I have faith in China is that it has historical proxies. Since 1970, with the exception of a few OPEC members, only four economies have made the transition from emerging to developed markets (meaning their per-capita incomes exceed $15,000 per year): Taiwan, Singapore, Hong Kong, and South Korea.

These four economies have two things in common. First, they have few natural resources; and second, they are dominated by Chinese values and the traditional Chinese work ethic. Mainland China is different only because it got a later start.

There has never been a better time to buy China
These historical precedents are why the wholesale abandonment of Chinese stocks is so remarkable. There's no place on Earth that is a surer thing to become a mercantile success.

This isn't to say China won't have its share of failures and abuses -- there will be fortunes lost in China, just as they have been lost everywhere. But the recent market downturn gives investors a bit of a do-over. We now have the ability to buy into great Chinese companies at the beginning of the Chinese Century, at prices that would make you think that great companies such as Aluminum Corp. of China (NYSE: ACH  ) and Baidu.com (Nasdaq: BIDU  ) are in permanent decline.

But they aren't. No way, no how, even though things may be bad for a while. But when the market prices for a hurricane and the only thing that's coming is a rainstorm, that spells opportunity the likes of which we may never see again.

At a time like this, when confidence comes dirt cheap, my Global Gains team and I are aggressively looking for choice opportunities in China, as well as in other markets. If you'd like to see what we're recommending now, click here for a 30-day free trial. There's no obligation to subscribe.

Bill Mann bu shi wen chi doufu. Seriously, I can't believe you asked that question. Bill owns shares of McDonald's and Guangshen Railways. Guangshen Railways is a Motley Fool Hidden Gems Pay Dirt recommendation. Baidu.com is a Rule Breakers recommendation. The Motley Fool's disclosure policy has nothing in common with Elvis Presley.


Read/Post Comments (8) | Recommend This Article (50)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 08, 2008, at 2:19 PM, FredHutch wrote:

    this biomedical search engine is a good example of chinese innovation - http://www.vadlo.com

  • Report this Comment On November 09, 2008, at 6:12 PM, BetterBizBooks wrote:

    These are things I've been talking about in my blog at http://www.BetterBizBooks.blogspot.com for awhile. I COMPLETELY agree with this train of thought.

    1) You still have businesses that haven't gone from regional to national players. Some aspire to this...

    2) You haven't seen the growth in the middle class and their increased spending (travel/retail)

    3) There are many industries where consolidation is RAPIDLY occurring. These businesses will leverage themselves once the China has built out its infrastructure (rails/highways, etc.)

    4) A $586 billion stimulus package is HUGE. More than the $150 to $200 million we spent in February to give back to consumers.

    Dan Ross

    http://www.BetterBizBooks.blogspot.com

  • Report this Comment On November 10, 2008, at 3:46 AM, Oilyboy wrote:

    Bill,

    I’d like to offer a few insights into China as I live here now and have for the past four years.

    First, the belief that China has resilient domestic consumer growth such that it can withstand any global slowdown is largely not true. There is a well known ongoing massive global slowdown causing a sharp decline in Chinese export growth. This is obviously leading to many factories closing and layoffs to people who have been the spending behind domestic growth. Bloomberg reported half of toy factories are now closed for example. Likewise, it is not just the primary export factories that are now shutting but factories that support the export factories also. This is a much more serious problem and the real crux of the problem. Anecdotally, I have a close friend who manages personnel staffing for large multinationals working within China – household name companies. She says the big companies are shuddering large hiring programs for semi skilled and skilled workers. They are just stopping hiring. These job losses and the knock on effects to job losses are going to have an impact and it will be wider than believed. Any thoughts China's growth is going to be >5% are very optimistic in my opinion.

    Second, another issue not widely understood is the shifting priorities for the Chinese gov't as part of the current five year plan. For those that don't know - China plans five years at a time and does not change midstream no matter what. The previous five year plan focused spending on the coasts and building export centers - it worked great (mostly) and spurred massive job creation, income growth, and GDP growth. It also created massive income inequality, skilled people migration, pollution, inflation, urban property bubbles, and poor resource allocation. The latest five year plan shifts focus to domestic infrastructure buildup and spending in the interior parts of the country. When the Chinese change tack like this, it is as if a light switch goes off one place and turns on somewhere else. Immediate, abrupt, and complete. This is going to significantly affect on the growth surrounding export businesses just as global consumption is waning. A doubly whammy for some industries, but for the Chinese they are seeing large disparate growth from which social unrest can result - a mega red flag for the gov't and a higher priority to redress.

    I believe there is still tremendous opportunity within China, but you have to read the tea leaves and follow where the money is going. By my way of looking at things - alt energy, water, heavy construction, roads, cement, and infrastructure are the places to look for the next wave of growth.

    One final thought, the Chinese are not as concerned about this temporary financial crises as you might think. It serves as a useful 'time out' to the unbridled growth witnessed in the run up to the Olympics. Barring a major default by the US gov't on it sovereign bonds, they will keep on with the steady and long term plans. They plan five years at a time and 1000 years into the future. This too shall pass for them.

  • Report this Comment On November 10, 2008, at 1:58 PM, sb1963 wrote:

    I would likfe to comment about the following passage:

    "These four economies have two things in common. First, they have few natural resources; and second, they are dominated by Chinese values and the traditional Chinese work ethic. Mainland China is different only because it got a later start."

    Yeah, right... It seems to me, there is another not so subtle difference: political system. Does it occur to anyone that is the reason for a late start? You know, Chinese economy is different for that reason alone, so I don't think it is a wise idea to extrapolate SK, HK, Singapore or Taiwan history to mainland China.

    I am not saying it will not grow, I am just implying it is uncharted territory.

  • Report this Comment On November 10, 2008, at 2:24 PM, TMFOtter wrote:

    I think that if you look at the political systems of Taiwan, HK, South Korea and Singapore in the 1970's and 1980's that they have dramatic similarities with that of China today. None of them were, case in point, functioning democracies, with South Korea, Singapore and Taiwan all operating as de facto or de jure single party states.

  • Report this Comment On November 13, 2008, at 10:41 AM, none0such wrote:

    The government of China is a big negative and a big positive when it comes to making money there. Obviously tread carefully. There is big money to be made there - but I prefer to do business where private property rights are ... well GIVEN would be nice but under the current arrangement FAIRLY dealt with under the law is a minimum for doing most any business there.

    Also the high GDP in China has always been in part do to capital in-flows (still waiting for Bill to address this issue and give his opinion on how much he thinks direct foreign investment contributes to padding GDP)

    With the Chinese housing market (another large piece of their GDP) slowing and the taxation and fees from this, until recently, frenzied and wholly non-stereotypical Chinese behavior falling, don't you think, Bill, there could be more to this Chinese sell-off to come for some time? What goes up must come down and all that ... right?

  • Report this Comment On November 13, 2008, at 10:43 AM, none0such wrote:

    @OctoberFaith

    Oliy's concluding remark that the Chinese Government plans in 1000 year increments is a thinly veiled allusion to the Third Reich which was to last for 1000 years. You see, fascism and communism are really two sides of the same coin - they don't respect people's basic rights

  • Report this Comment On November 13, 2008, at 10:57 AM, none0such wrote:

    @TMFOtter

    Taiwan is now a functioning democracy? That is a matter of opinion. Did you ever see their Congress in session? Watch out for flying lunch boxes and fist fights. How about this week's pictures of their former President paraded in front of the media in handcuffs while on route to being "detained", not formally arrested on corruption charges. Hmm, wait a minute, maybe they're on to something there!

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