Director of Research and Co-CIO
Hahn Investment Stewards
The Bear Case Is Widely Known; Consider The Bull Case
The bearish case for China is well known—including overleverage, overbuilding and overcapacity (China continues to invest half of its GDP)—with a declining return on investment for the state sector. On top of that, there is a large, opaque "shadow banking system" that poses a systemic risk to the entire credit system.
On the surface, most of these arguments appear bearish. In particular, breaking up the state-owned monopolies will surely come with dislocations and unknown risks. The transition will be hazardous.
However, all of the above is the widely accepted outlook. How much is priced in? China shares, particularly banking stocks, are cheap. Shorter term, they could easily fall further. But taking a longer view, consider some bullish arguments:
First, concern with rising wages is overblown simply because that trend reflects rising productivity. Chinese firms continue to increase global market share, even though manufacturing wages are up 7 times since 2000.
Second, the Chinese economy remains flexible, moving much of its low-end manufacturing sector to other jurisdictions or moving to higher-value-add enterprises. This is a classic example of an economy transitioning to more market-based forces.
Finally, continued growth in the "shadow banking" system may be a sign of progress (as it is more market driven) and not approaching crisis. Over time, the official Chinese banking system will look more like the shadow one, not the other way around.
[Bill Witherell's opinion is next.]