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Yoshikami: China's Headwinds

Apartments in China
Apartments in China

Much has been talked about regarding China and its emerging presence as a dominant world force. We believe that the seeds have been sown for China to be a global leader in economic activity for decades to come.

But before becoming too euphoric about the prospects for this economic giant, we should recognize that China does face headwinds.

There is no doubt that China is a growing economy. With a current growth rate of approximately 8%, it far outpaces Western economies in terms of actual GDP growth. But below the surface, there are structural problems that need to be recognized. We carefully assess these trends as we make investment decisions.

Here are a few items of concern about China:

1. China's demographic problem: China’s one-child policy has led to an aging population. As this older population continues to age, China will be required to spend more money on health care infrastructure and other social services. One might argue that this may not be a priority for China given that culturally the younger generation is encouraged to care for the older generation. But there is a limit to how much the younger population can care for their elderly. Even if older Chinese live with the younger generation, their healthcare needs will likely be costly. This cost will be a drag on economic growth.

2. China's Population: As the Chinese population continues to grow, efforts to convert the Chinese economy from an mostly export to a more balanced consumer and export economy will be a challenge. The dream demographic for advertisers in the U.S. is 25 to 49-year-old T.V. viewers. This is the segment of the population that spends the most money out of their disposable income on ‘aspirational purchases’. As the Chinese population continues to age, there will be less motivation for the older population to spend. With a smaller group of consumers available to bolster the Chinese economy, this will create problems as China attempts to diversify its economy.

3. Chinese labor costs: Yes, China still has very low labor costs compared to factories in the United States. A recent study conducted on a major manufacturer showed that the average Chinese worker was making near $4 per day, where an equivalent salary is much higher in more established economies. The differential wage gap has resulted in Chinese capturing a large percentage of the manufacturing market. But there is some evidence there is a backlash against low labor costs. Some workers have privately discussed organizing labor unions, and there has been more competition in Chinese industry for skilled workers. There will likely be price pressures to increase wages. When that happens, the Chinese economy will likely slow.

4. Chinese real estate: One only needs to fly intoShanghai or Beijing and see the rows and rows of empty condominiums and office buildings built by government funds in anticipation of growth that has not yet occurred. The Chinese economy is growing strongly, but Chinese real estate has undergone a massive build out which is underutilized at this point. As the economy slows, real estate prices are beginning the slow decreasing the netwealth effect for Chinese. Any reduction in wealth is likely to have a negative impact on the Chinese economy

5. Flow of information: Given the rapid dissemination of information as a result of technology, it is sometimes problematic to try to restrain freethinking. China tries but it is not easy. Just recently protests occurred in response to the Chinese crackdown on street vendors, and many have suggested that the riots in the Arab world are indicative of what might happen in China. Let's be clear; the Chinese government is worried about political and social revolution and for that reason are doing all they can to try to control media and Internet usage. But perhaps the genie is out of the bottle. This is surely going to lead to political and cultural changes which will no doubt impact economic agendas of China’s authoritarian government.

These five issues surroundingChinese economic growth do not dispel the reality that we currently see in the Chinese economy. China is a rapidly growing economy with a 8% growth rate. They have a massive labor cost differential and will continue to benefit from this differential for years to come. But China is no longer growing at 15% a year. Our view is that this high growthtrajectory is finished.

There are other countries in Asia besides China. Our perspective is to diversify portfolios across a number of emerging markets and not just focus on one country. Because China is mostlyabout exports, investing only in Chinese equity assets for your emerging-market investment strategy then means that you essentially are buying only the export sector and that is not diversification.

Michael Yoshikami, Ph.D., CFP®, is CEO, Founder and Chairman of YCMNET's Investment Committee at YCMNET Advisors. Founded in 1986, YCMNET is a San Francisco Bay Area-based independent money management firm that provides fee-based wealth management services to institutional investors and individual investors. The firm works with clients around the world. Michael was named by Barron's as one of the Top 100 Independent Financial Advisors for 2009 and 2010. He oversees all investment and research activities of the firm and is actively engaged on a daily basis in the firm's securities analysis activities and determines the macro tactical asset allocation weightings for client portfolios. He works with YCMNET's investment team in integrating behavioral investing strategies with the firm's core fundamental perspective. Michael holds a Ph.D. in education, other advanced degrees, and holds the Certified Financial Planner® (CFP) designation.

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