Malkiel: Investors Need To Own More China

June 14, 2011

Own more China and hope U.S. politicians start talking seriously about entitlements, Malkiel says.


Burton Malkiel, author of the indexing classic “A Random Walk Down Wall Street” and the chief investment officer of the China-focused indexing firm AlphaShares, thinks most investors probably don’t own enough of China in their portfolios. He acknowledged that economic growth in the world’s most populous nation may have slowed but it’s not about to stop.

The Princeton University economics professor also told Managing Editor Olivier Ludwig that he continues to fret about the “paralysis” in Washington, D.C. regarding addressing the long-term viability of entitlement programs such as Social Security. A serious discussion about bringing these liabilities under control would go a long way to giving the U.S. economy a much-needed shot in the arm.


Ludwig: Regarding China, how do you respond to views that all that GDP growth won’t necessarily translate into growth in asset prices?

Malkiel: There is a well-known study that suggested there was little correlation between a country’s GDP growth and how well the stock market did. A lot of people use that and say: “You can have good GDP growth, but that doesn’t mean a good stock market.” The problem with that study is that it was very time-dependent, and in particular, it showed little correlation over the period they used for China. And the reason was that at the start of the period, Chinese stocks had almost triple-digit price/earnings multiples. In other words, if you start this during a period when valuations are stretched, then it’s quite possible—even indeed likely—that there’s not going to be stock market growth commensurate with the GDP growth.

In general, when P/E ratios are stretched at the beginning of the sampling period, you don’t find a correlation. However, when you start a study when P/E ratios are moderate, then my studies suggest there is a strong correlation between GDP growth and the growth of market equity. And the reason I am very optimistic about China now is that P/E multiples are quite moderate. On our ETFs, for example, we’re talking about P/E ratios that are in the midteens.

Ludwig: So what about China’s overall growth prospects?

Malkiel: I was in a debate with someone about China, and they said: “Oh, China’s terrible; it’s a stop-and-go economy.” My answer was, if stop-and-go means that growth had been 10 percent a year and then, during the crisis, it went down to 7 percent a year, then I’d sure like that kind of growth for the United States. It’s better than any other country in the world. It is slowing down; there’s no doubt about. But it’s still going to be darn good, and valuations are moderate.

Ludwig: Regarding inflation in China, do you see currency appreciation as a powerful way for China to minimize the impact of inflation?

Malkiel: Absolutely. China’s not going to let its currency go up because we tell it to. They’ll do it because it’s in their interest.


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