china the next chapter

China: The Next Chapter

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Simplistic arguments about China’s investment prospects suggest that since the country’s economy is no longer growing at double-digit rates, its best days are behind it. Most of this argument focuses on total GDP growth, gross capital formation rates, levels of fixed asset investment and gross export growth, to name a few of the indicators from China’s 1990s and early 2000s investment playbook. If these macro indicators were the most relevant to in- vesting in China in the years ahead we would concur that the best investment opportunities lay behind us. This approach, however, focuses on seeking answers to the wrong question. It focuses too much on the ‘what’ (what will be China’s GDP growth this year?) instead of on the ‘how’ (how will China’s economy grow this year?). The needs and wants of China’s population today are very different than those of 40 years ago. Therefore, it is even more imperative to frame the questions around growth appropriately.

Which brings us to two important questions: How will the Chinese economy grow in the near future? And what are the factors that will propel this growth? In our view, the biggest factor in propelling China’s future growth is the increasing purchasing power of a massive mid- dle-class. Coupled with the government’s concerted efforts to become a global technological leader and ample pools of capital, the arguments for ‘owning’ a piece of the Chinese new economy are compelling.

Investors, however, need a new playbook to avoid the pitfalls that befall many investors in emerging markets. For starters, recognition that China is more of a standalone investment category rather than a piece of the traditional emerging market pie is important. The prima- ry reason for this is scale. Not only is China’s economy too big to be grouped with all other emerging markets in a single category, but also the country’s massive foreign exchange re- serves, deep savings base and position as net creditor to the world allow it to march to the tune of its own drum. Thus, an allocation to Chinese equities, in our view, should stand sep- arate from an investor’s emerging markets allocation.

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