Is China Undervalued Right Now?

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During the past few years, China has become an increasingly compelling destination for investment capital. But with the recent weakness in the Chinese stock market – and serious cracks showing in the façade of China’s economy – does it make sense to invest in China right now?

One money manager I know thinks so. In fact, he thinks that some of China’s US-listed stocks are trading at low enough valuations to triple in 2010 regardless of how the economic situation unfolds… I’ll introduce him to you in a minute.

There are two parts of the macro backdrop that are important to understand about China. First, there has been a tremendous increase in bank lending since the end of 2008 – it’s up something like fourfold. And we know from experience that when banks grow that fast, bad things tend to happen later. What happens when banks grow that fast is that they slide down the credit-quality spectrum. In short, they make tomorrow’s bad loans.

Secondly, we know that the Chinese government has put in place a huge stimulus plan. And again, we know from experience that when governments invest money, you inevitably wind up with “bridges to nowhere” and all kinds of boondoggles. The money doesn’t flow to its best economic uses, but to political ends.

In Beijing, you can see some tangible effects of this. I recently visited, for instance, the largest mall in Asia. It was built six years ago by state-run enterprises. They put it on the western edge of the city, about 40 minutes from Tiananmen. Real estate people thought it was a bad idea. It was too far away…and too big.

Well, the pros turned out to be right. And today, the place is virtually empty. It was almost eerie walking through there. There were lines of bright shops with neatly dressed attendants and shelves full of the latest products from the world’s best brands. But there were no customers.

This place has over 10,000 free parking spaces. There is over 1.8 million square feet of retail space here – over 167,225 square meters. That’s about three times the base of the Great Pyramid at Giza.

It makes you wonder. Why did this place ever get built? And boy, are they losing their shirts. But then you wonder about the shops themselves. Why do they stay? How can they possibly make money here? It’s all very strange.

But then you go 30 minutes into town and visit another big mall packed with people. The parking lot is so full you have to wait to get in. When one car leaves, they let one in.

The residential property market also feels bubbly – a lot of construction going on despite widespread tales of empty apartment buildings. One rationale we heard from people here is that the Chinese view property as a store of wealth. We heard stories of how people buy brand-new apartments and don’t even attempt to rent them out. They just hold onto them.

Interestingly, besides property, the Chinese also like gold as a store of wealth. China is the world’s largest consumer of gold (and its largest producer), only recently passing India. So if there is a property burst, gold should be a winner. In fact, while I was here, CCTV News – China’s big television network – reported that China is seeing a surge in gold buying recently as people here start to get nervous about a potential property bubble.

As you can see, China’s economic picture is complex – as it is everywhere, really. The US economic picture is equally murky and uncertain.

However, in some ways, you don’t have to figure it all out. I met with a money manager here – a low-key guy whom I cannot name. Yet his fund is up over 1,000% in 10 years. He knows the China market as well as anyone. He was short the market – that is, he was betting it would fall – as late as January, but he is now buying again.

As he told us, there are some Chinese stocks that are also listed in the US that trade at very low multiples of earnings. Some of them, when you net out the cash, trade for as little as 3 times earnings. As he says, you don’t really need to have a positive view on China to buy these.

When asked about the China bubble, he told me. “I don’t really care. I know I can buy some stocks that could well double in six months, regardless.”

Though even here, the market is tricky. You really have to know what you are doing. There are bad auditors and shady accounting practices here, as in the US. And there can be big gaps in quality between certain names. It’s a market for which it helps to know people on the ground who know the quality of the management teams.

Chris Mayer
for The Daily Reckoning Australia

Chris Mayer
Chris Mayer is a veteran of the banking industry, specifically in the area of corporate lending. A financial writer since 1998, Mr. Mayer's essays have appeared in a wide variety of publications, from the Mises.org Daily Article series to here in The Daily Reckoning. He is the editor of Mayer's Special Situations and Capital and Crisis - formerly the Fleet Street Letter.
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Comments

  1. Nah… China is just bubbly – ing.

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  2. China; India; Asia – Bubbly? Effervescent even??? But reasonably satisfactorily positioned to remove the intestines from the old world perhaps? They have savers and producers. Whilst we have consumers and financial advisors … :)

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  3. Wonder if our financial advisors are still smart enough to continue winning the war after fooling them in the late 1990s? After giving them lots of repeat warnings we hope to continue playing similar games this decade? Slopey Dopies Beware!!! :) Because WE got more fiscal ammo than you … :) – For now??? Providing you keep lending it to us – Please? teehee :(

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  4. “They have savers and producers. Whilst we have consumers and financial advisors … :) “*

    True, but compared to the States, we’re small beer, Ned.

    A mate of mine is off to China for a few weeks. Too short a visit to really get any kind of worthwhile assessment, but I’ll be interested to hear their views on return.

    * Along with Canada, we have holes-in-the-ground too, don’t forget!~ ;)

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  5. here’s a sensible article from the off-side and waiting Malcom turnbull on Oz reliance on China. Now if we could only hear this from the PM in mandarin

    http://www.smh.com.au/opinion/politics/chinese-debt-binge-is-fuelling-a-dangerous-property-bubble-20100615-yd1a.html

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  6. Can the Chinese Government really stop speculated property prices from dropping…can any Government, and IF they do, is it really a wise move?

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  7. Great link, Peter. Thanks.

    While one can disagree with Turnbull’s exclusion of property from the ‘hard asset’ category, Chinese citizens’ purchase of apartments and homes _deliberately left vacant_ is speculation rather than investment. There’s no great value to their society in this, other than increased employment,
    I guess. Perhaps a higher tax base from that, too.

    What Turnbull appears to have overlooked is the claim that the Chinese practising this speculation are putting 80% down… and borrowing 20%. Yes, in Turnbull’s scenario of a collapse similar to that in Japan, their equity would stall or fall. This might mean those properties were forced to ‘work’ for the owners. That’s not too bad an outcome for China, IMHO.

    Much is said about Japan’s housing situation of the last two decades.
    For speculators, it has probably been disastrous. For investors it has probably provided great comfort, with low interest rates reducing their costs significantly.

    Having offsets equalling loans has a similar appeal.

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  8. Housing ‘investment’ is not viable for current RoI’s in Australia. Only speculation is viable. Hence the reliance on capital gains.

    Talkin out your stink hole as usual Biker.

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  9. Jeez, you’re a sad case, Pete. I see you’ve had your morning cup of vitriol! :)

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  10. Quote:

    “The way I see it is this: a home worth 800k is composed of 2 sums of money. Around 300k or so for the house and property and around 500k as a payment to the baby boomer owner for being born before me. ”

    This is not my quote but it is a quote that is true

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  11. Great quote, Steven. Five stars!~

    May I suggest you put the quote on a placard to take to housing auctions.
    Most bidding there probably _won’t_ be baby boomers; so I expect the $800K property will sell for close to $300K, based on the truth and logic of your argument.

    If this _doesn’t_ work, avoid any auction or sale where you see an infestation of BBs. Those bb*stards (large Australian flightless BBirds) are responsible for all the world’s ills, just as they were sixty years ago, when I was a kid.

    Nothing changes, mate. ;)

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  12. Will not have to do that Biker, the greater fools are running out as we speak!

    When you want to sell one of your “investment properties” and you want to sell it for 500K and a similar house up the road goes for $400 K.

    You just make sure you arrogantly tell all the people coming over to inspect your house that the price is 500K and thats final.

    You make sure you tell them that and see what they say HAHAHA

    But no you wont do that you will drop the price and do as you are told

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  13. Will you _buy_ when prices drop $100K, I wonder, Steve? Probably not.
    Because you believe they’ll fall further, you’ll wait… and wait… and wait.

    Your patience is admirable, son.

    We’ve never, ever sold when prices are low, Steven. Smart investors
    a.) pull properties off the market; b.) hold through tough times (including rates of 17.5%); c.) cover repayments with rent; d.) …and this one may surprise you… put prices UP, when they’re serious about selling. This has failed us just once. When prospective buyers see the posted price rising, monthly, they jump in… generally negotiating to get the _second last price_… ie., the price posted just prior to the current one.

    I could probably _teach_ you a few things about realty, but you seem to know it all. (I’m still learning… . :) )

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  14. “We’ve never, ever sold when prices are low” – I own three – Outright. And have cash. I would not envisage selling any this decade. As I find it convenient to have one to live in. And another is in the name of my SMSF. With the plan being that the rent from it will top up whatever my other retirement income might happen to be – With being an aged pension recipient on full perks who owns his home and is debt free and has the rental income from a house held in a SMSF sounding surviveable as a worst case scenario maybe? Whilst definitely not affluent of course.

    So technically that leaves one “spare” house perhaps. Why not sell it this decade? Well, even at the much maligned concessional CGT rate, I can’t see exceptional sense in flogging off a property that earns me maybe $12K pa after expenses and paying the guv lots of tax on the deal – When the alternative is to let it sit there for another decade and earn $100K plus rent perhaps – With me only having to worry about what I would invest the balance in if I did sell it?

    And the option always exists to buzz off overseas to a place where one can live OK on maybe $20K pa – Which renting out my home and having that place that isn’t held in the name of my SMSF would go close to covering after tax anyway. Whilst I wait to be able to get access to the rent from the house in the name of my SMSF as well. And think a bit more about what I might want to do with that cash I mentioned maybe?

    Is that sort of thinking smart? Well, I doubt it’s a plan Goldman Sachs would come up with? But given that I’m pretty risk averse, and accept the fact that I’m pretty stupid, I can live with it – If no more attractive options should ever happen to present themselves to me personally, between now and “doomsday”. :)

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  15. “Is that sort of thinking smart?”

    Yep.

    But I don’t think I’ll let the missus read it, Ned!~ :)

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  16. The most hopeful recent thought re timing I’ve seen from a bear on Oz property of any repute was “Australia buyers might need to wait 5-7 years or more for reasonable valuations” – Typical! If he’s right about the “more” bit, and in worst case scenario, I just could be considering off-loading a property about the time that valuations are becoming “reasonable” – I never have been any good at timing markets! :)

    http://www.marketoracle.co.uk/Article16958.html

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  17. “When the alternative is to let it sit there for another decade and earn $100K plus rent perhaps” should have read “When the alternative is to let it sit there for another decade and earn $100K plus [IN] rent perhaps” – I’m not reliant on capital gains.

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  18. 7:20 pm, 16/06/2010: Took some meth and a rag and walked out in the dark, down to our sign to erase the price. It now reads: $ K

    I’ll get a call by midday… .

    My plan is two sell two or three off in July, Ned. Travel abroad six months in 2011 on the interest. I’m happy with 30% profit.

    (Not _everyone_ is happy to sell, mine dew!~ )

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  19. Very much a matter of personal circumstance (as opposed to opinion) maybe Biker?

    “Six feet from his head to his heels was all he needed” – Amen – To be dead – But not to be alive!

    Just personally, I reckon Tolstoy might have been a bit better off drinking a few more vodkas occasionally meself? :)

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  20. Not sure why some blokes seem to get their knickers in a knot over your comments Biker? – You basically say There, there, it’ll all be alright! Whereas Tolstoy might have said Yeh, the West has reached its zenith and it’s all downhill from here forever until the world reverts to its long-term median population, living on it’s long-term median m2 arable land per capita with its long-term median gold price per oz with its long-term per capita median income being averaged out across its surviving citizens to yield them each their long-term per capita standard of living perhaps? Or somesuch??? I would have thought your message was more appealing myself? :)

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  21. Not sure why some blokes seem to get their knickers in a knot over your comments Biker?
    Yeah theres just no need Ned but it is inevitable. Biker is just doing the Gods work..ya know ..refining the chosen bears thru fire or something ;) At least he enjoys his day job…so much so he even breaks in to poetry of a Sunday occassionally. I think you missed our poems Ned..
    Happy day Ned.

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  22. HaHa… Definitely not God’s work, Lachlan… but it does keep me outa mischief! Not everyone would agree. Read on…

    As far as reassurance, I’ve been doing this for a very long time now; and
    I’ve noticed some interesting patterns. I’m seeing one of them repeated again, right now. First and second sons, in their late teens and early 20s, using their folks’ internet address to make queries about property, specifically land. Not the price, because they can see that on the sign. So they’ll ask about the square metreage. What they’re looking for, of course, is that response Steven mentioned: capitulation. How do _I_ know? Well, I’ve done it myself… waiting for an email or phone call to let me know there’s some slack in the price. It’s a game of patience.

    But after this little drama has been played out for a while… and the good blocks all get builders’ signs on them… even mum and dad get a little tetchy. Then the price disappears from the sign for several days.
    Then a new price goes up. We used to raise the ante $10K at a time.
    These days we raise it $3K – $5K. If the asking price is fair, that’s enough motivation. And remember, we do accept the price posted before the current one, because the buyer made a real bid. The aim is not to gazump the price, it’s to get a firm commitment… a sale.

    When the process takes a long time, however, the eventual price is sometimes many multiples of the original. When there’s no sale, most players believe the price will drop… and it just keeps getting higher. Smart(er) buyers (like me) just laugh and walk away.

    Now some bears here will shout “Mischief!” Consider the buyer’s true motivation, however. He sees the sign with the handwritten price… and, like Steven, smells blood-in-the-water… and HE starts the game.
    He doesn’t know this hand has been played many, many times before.

    A really smart buyer will not mess around. He does his homework. If the price is fair, he pays the asking price first up. If he’s even smarter he’ll _ask_ outright if there’s any give-and-take in the price. No games.

    I’ve recounted this process simply due to Steven’s last comment: “But no you wont do that you will drop the price and do as you are told… ”

    It pretty much sums up the naivety of a few bears here.

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  23. DR(US) has an interesting article “Ten Benefits of Expatriation”, today.
    It could almost be retitled ‘Why Australia is Different’.

    A good read…

    Reply

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