China: Are There Trouble Signs Ahead?

The rise of China over the past decade has been nothing short of astounding. The country’s consistent double digit growth has resulted in their GDP eclipsing Japan (on a purchasing power parity basis) as the world’s second biggest economy with expectations of overtaking the United States in less than 20 years.  Many leaders and pundits have touted China’s economic model, which combines aspects of central economic planning with capitalism, as superior to the more free market economic model that has been adopted by most developed economies because it allows the government to act more swiftly during times of crisis. There are, however, signs that China’s well-polished economy may not be as perfect as once thought.

While there has been talk of a real estate bubble in China for quite some time now, only recently have we begun to see the extent of this bubble. In March of 2011, a team of reporters from Dateline Australia travelled to China to document the growing number of empty cities in that country. At the time of the report it was estimated that there were more than 64 million empty apartment buildings in China, enough to house more than 200 million people. It appears that in an attempt to maintain GDP growth and employment, the communist government of China has been developing massive real estate projects for which there is currently no demand.

Another issue that could have a significant impact on China’s long term growth prospects is their rapidly aging population, a result of the one-child policy. It is now estimated that within the next 10 years China’s population will peak and then begin to decline. The government burden of caring for an aging population while the size of the Chinese workforce is dropping could be staggering.

The possible implications of China’s real estate sector declining and slower Chinese GDP growth are numerous and could have a cascading economic effect. Of particular concern, China is a massive consumer of a wide variety of commodities including many base metals and oil. Slower economic growth in China would undoubtedly hurt commodity prices, affecting many Canadians who are often overexposed to the energy and material sectors of the stock market (given that they represent a large proportion of our domestic stock market).

At Bridgeport, we generally avoid commodity stocks as it is incredibly difficult to predict the corporate earnings of these companies given that they are so dependent on underlying commodity prices which can fluctuate wildly. Instead, we focus on attractively priced businesses that have high levels of recurring revenue and over time are able to pass on price increases to customers without impacting demand for their products or services. We believe this approach allows us to deliver more stability in investor returns over time.

Check out this fascinating documentary by Dateline Australia.

http://www.sbs.com.au/dateline/story/watch/id/601007/n/China-s-Ghost-Cities