Consumption Is Changing the Face of China 

Kunal Ghosh 



Kunal Ghosh discusses the implications of China’s move away from an export-driven economy and its likely positive effect on consumer stocks.

Consumption is changing the face of China

To better understand China’s transformation to a consumer-based economy, it is important to note that in the previous decade, China’s growth hinged on creating infrastructure to service export demand from the West. This has turned in the last two years: As a percent of GDP growth, consumption has increased from 45% to 54%, on average. This trend—which we believe is sustainable—should result in increased reliance on consumer spending. Here, there is room for growth: Consumer spending accounts for about 35% of GDP in China, compared with more than 50% in South Korea and more than 60% in Brazil, Japan and the US. We believe China’s economic profile is ultimately heading in the direction of these more mature economies.

What will facilitate further consumption growth in China is the gradual appreciation of the renminbi. China’s currency has held up well, and we believe it will gradually appreciate in value and will ultimately be conducive to an increase in China’s consumption—although we are still in the very early stages of what will be a long-term growth story.

We also need to recognize that this transformation is not just about buying more clothes and food; it’s about a better lifestyle. Trends like the following are long-term, investable themes where we believe significant outperformance can be found:

Casinos in Macau. Growth in gaming revenue is steadily increasing as the Chinese become wealthier and look for ways to spend their income.
Health care. It’s a luxury that wasn’t available in China 20-25 years ago. Today, with better doctors, medicine and a hospital network, health-care spending is on the rise.

Consumer stocks show new strength

Given this consumption growth story, we have been examining three areas to understand what’s behind the trend:

hard assets, such as commodities and mining;
exports, particularly companies selling to the developed world; and
consumer-related stocks in which the Chinese consumer is the end user.

Up until the financial crisis in 2008, all of China’s market returns were delivered by hard-asset companies, with consumer stocks the worst performers. However, during the financial crisis, this situation completely changed: The best-performing stocks were consumer-related ones, while the worst were hard-asset stocks. The reason is because people remained employed despite the crisis and continued spending, so consumer companies exhibited solid earnings growth and were rewarded. After the financial crisis, export companies became the worst performers.

While many market watchers have been cycling through alternating feelings of serial depression and euphoria about China, if you take seriously the move toward a consumer-driven economy, you can see enormous opportunity for good returns from the Chinese market—but you must look carefully. Couple China’s strong earnings growth with cheap valuations, and there is a very positive long-term outlook for the country in the long-term, consumer-related theme.

Inability to implement reform poses risks

If there is a short-term risk to our outlook, it is China’s overleveraged balance sheet. The leverage is now in hard assets and property developers—but the fact is, if some property developers were to go under, we believe it could actually be good for the country.

Looking at the long-term picture, China’s new government came in to make reforms. For this current consumer trend to last 25 years or more, we need to see real change in health care and the social security net. As such, the biggest risk over the long term would be the government’s inability to implement these changes, but they only recently came to power and we believe that, so far, they are taking the right steps to bring about positive reform.

The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.



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