SINGAPORE (Oct 21): As a US diplomat and then China analyst for more than three decades, Andy Rothman had a ringside seat for how China emerged from the rubble of the Cultural Revolution, advanced after the Cold War and grew from being “basically irrelevant” to world trade to become the world’s second-largest economy.
The year-long trade war, which has driven US-China ties to a new low, has saddened Rothman. All the drama, accusations and tensions happening today are scenarios he did not imagine when he was with the US State Department. “I feel disheartened, especially by the prevailing view in the US. Those four decades of engagement between the US and China and between the US and Europe have failed,” says Rothman, an investment strategist at fund manager Matthews Asia, in an interview with The Edge Singapore on Oct 8, just when China’s vice-premier Liu He arrived in Washington, DC to resume negotiations.
The past few decades are “far from perfect”, but from an economic point of view, they have been good for both China and the US. Chinese citizens enjoyed tremendous income growth, while US consumers enjoyed higher spending power, thanks to made-in-China products. “Without China, arguably, there would not have been the consumer electronics revolution,” Rothman says.
He disagrees with US President Donald Trump’s stance that there is an imbalance in the US-China trade relations and that he is merely doing his bit to right the wrong. Rothman believes that Trump, who has focused almost purely on the bilateral trade deficit to wage his war, received “bad advice”. The deficit aside, China has been accused of not complying with the terms of the World Trade Organization (WTO) agreement to which it became a signatory.
“My response is, if that’s the case, then how come US exports to China since joining WTO have increased 500%, whereas US exports to the rest of the world were up [only] 100%? [How come] US agricultural exports to China rose 1,000% from the time China joined WTO to the beginning of the Trump administration, and General Motors Co is selling more cars in China than in the US?” says Rothman. In any case, he believes the US and China will reach a deal by year-end. Trump knows a deal is better for his re-election prospects, while China is eager to put the hostility behind it as well.
Instant noodles and infrastructure
Indeed, GM cars are not the only things sold to the Chinese. Rothman is a firm proponent of the Chinese consumer story, which is one largely immune to the trade war, or “trade dispute”, as Rothman describes it.
For actively managed funds, there is no shortage of stocks to pick, riding the common underlying theme of higher spending power by 1.4 billion Chinese. “People tend to think of China as a cheap manufacturing place, a place that builds a lot of bridges and houses, but in fact, its economy is increasingly more like the US’, driven by consumer spending in goods and services, especially in services lately. And, I think, data shows that that story is holding up really well right now,” says Rothman.
He notes that income growth in China has been “phenomenal” in the last couple of decades. In real inflation-adjusted terms, over the past decade, average per capita income in China has gone up 120% and in the US, 17%, which translate into annual growth of 8% and 2% respectively.
Rothman acknowledges that inflation in China is rising too, and certain categories, such as healthcare, have been growing at a much faster pace than others. Nevertheless, the core Consumer Price Index has been kept at 2% or so — a level that most economists will agree is “pretty healthy”.
To be sure, the headline figures for China’s economy are not all that rosy. GDP growth has slowed to 6% — a significant drop from the 10% of just a few years ago. However, Rothman says the deceleration is not sudden, but has taken place gradually over the last decade. “It is also because the base has got so big, so the incremental expansion is enormous. Hence, the opportunity for Chinese companies to sell goods and services to the Chinese is actually much better today, at 6% GDP growth, than at 10% growth a decade ago. The [prospects] for investing in those companies are better,” he explains.
Investors also must look beyond the headlines for the real story. For example, according to recent headlines, China’s top 100 largest retail chains are suffering from lower sales. “That doesn’t mean consumers aren’t buying; it means they are buying more and more stuff online and from the small shops. Macy’s in the US is going bankrupt because nobody buys from department stores anymore; rather, they are shopping via Amazon and places like that,” says Rothman.
As another example, sales of instant noodles in China, which hit a low of 38.5 billion servings in 2016, have picked up in 2017 and 2018, when 40.3 billion servings were sold. The conventional logic is that consumers are worried that the economy is getting worse and therefore, they choose to eat more instant noodles, as this is the cheapest food option. However, upon scratching beneath the surface, the reason instant noodle sales are growing is because manufacturers have been introducing “premium” products — those that are tastier, healthier and come with more ingredients instead of an MSG pack. Prices of each serving can cost up to 50% more. “We need to be careful with the data. There’s usually a more interesting story if you dig [deeper],” says Rothman.
He is a bit more conservative when it comes to China’s property and infrastructure sectors, which saw massive investment and had driven growth for decades. He notes that a fair bit of infrastructure work still needs to be done beyond the coastal top-tier cities, but that the spending will be much further inland. “There are 150 cities in China with more than a million people each, so they are not completely done yet. There’s rural infrastructure that still needs to be worked on, but [infrastructure] is not as prominent a part of the economy as it was before, and not an area I would emphasise in general,” says Rothman.
He recognises widespread concerns that a bubble is forming in the property sector and that prices are getting increasingly out of reach for the masses. He points out that grumbles about affordability are heard not only in China but also in Hong Kong, London, Singapore, San Francisco and New York. “That’s not a financial system problem, that’s not a bubble, but a social and political issue — one they have to address,” says Rothman.
The key indicator to look at to determine whether a market has a bubble, according to Rothman, is how leveraged buyers are, not how high prices are. He cites the 1997 Hong Kong property market crash as an example. At the time, prices dropped 70% but the mortgage default rate stayed below 2%. The reason was that the properties were mostly primary residences. The Hong Kong government had required that aspiring homeowners make a 30% cash down payment. China has been doing the same thing.
By contrast, in the leadup to the subprime housing crisis in the US just over a decade ago, the median cash down payment was as low as 2% of the purchase price. “So, if housing prices come down 2%, the people are struggling with an underwater mortgage. That is why I don’t see bubble conditions [in China],” says Rothman.
Domestic demand
From Rothman’s perspective, investors should be aware of sectoral trends, but they need to pay more attention to the investment merits of individual companies. The trade “dispute” with the US — as he prefers to call it, has had relatively little net impact on China’s overall economy. After all, net exports are at less than 1% of China’s GDP. “The vast majority of listed companies in China are focused on their domestic market; they are pretty well insulated from the dispute with Trump. This is a domestic demand story,” he says.
There are companies exposed to the trade war, but they have long been “scrubbed” from Matthews’ portfolios, as seen from its funds’ performance. Year to date, the Matthews China Small Companies Fund has gained 12.77%. By contrast, the benchmark MSCI All Country Asia ex Japan Small Cap Index was down 0.05%. As at Sept 30, the fund’s biggest holding was analog chipmaker Silergy Corp, which made up 7.3% of its assets. Its next largest holding was shipping conglomerate SITC International Holdings, which accounted for 5.1% of its assets. Sunny Friend Environmental Technology Co, a Taiwan-based company that specialises in the removal and disposal of biomedical and hazardous wastes, was its third-largest holding, making up 4.9% of its assets. The fund’s lead manager is Tiffany Hsiao.
The Matthews China Fund, whose lead manager is Andrew Mattock, has a list of better-known stocks among its top holdings. It is up 15.45% year to date, versus the MSCI China Index’s 7.8%. Online giant Alibaba Group Holding was the fund’s biggest holding, making up 12.8% of its assets as at Sept 30. Other holdings include gaming giant Tencent Holdings (9.6%), Ping An Insurance Group Co (5.1%) and JD.com and Industrial and Commercial Bank of China (both 3.8%).
“Yes, the tariff dispute is there — I am deliberately not calling it a trade war; [it’s not at] that level yet. People are aware of it; it is having a modest impact, particularly on corporate confidence for investment purposes. But consumers are saying, this is not a big deal for me, and investors are saying, we are not really investing in exporting companies, so it’s not a big deal for us either. On top of that, valuations are pretty reasonable,” says Rothman.
