Is Anthony Bolton right about China?

By MoneyWeek Editor John Stepek Jan 26, 2010

John Stepek

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Shanghai skyline © pixinity/Shutterstock

China: is the party coming to an end?

Markets are suffering a real dose of the jitters.

Asian stocks fell this morning. They're now on track for their longest losing streak in two years, reckons Bloomberg. Meanwhile, both the dollar and yen – the classic 'risk-aversion' currencies – picked up.

There's just too much for investors to fret about. As one worry fades, another reappears. On the one hand, Barack Obama's banking reforms are being rationalised away. Broker notes are urging us to buy financials, claiming that the reforms probably won't make it through Congress anyway.

Greece also managed to sell some bonds yesterday (doubtless to the same people who thought that backing the Icelandic banks for an extra percent in interest was a good idea). This buoyed sentiment in the credit markets somewhat.

But now concerns about China tightening up have re-emerged. And investors are right to be worried. The Chinese are walking a tightrope which no central bankers have managed to cross without mishap in the past...

Growth is moving from West to East...

I was at a seminar on China yesterday, hosted by fee-only independent financial advisor Saunderson House. The star attraction was Anthony Bolton. He was talking about his reasons for backing China with his new fund.

Before you ask, he didn't go into the details of the fund. Those will be out later this year. But in terms of his rationale for investing in China, he made the usual bull points.

He argues that growth is moving from West to East. While we face sclerotic growth in the future, China and emerging markets are set to keep growing rapidly and overtake us at some point. And while Chinese stocks in general are not undervalued by any means, the market is less developed, and thus presents more chances to find quality at low prices.

... but remain sceptical about China

As you might have noticed, we're somewhat sceptical about the China story (read what Merryn Somerset Webb has to say about it here: My case against China - if you're not already a subscriber, claim your first three issues free here). And I can't say I heard much to convince me otherwise. I'm not saying for a moment that Anthony Bolton can't pick stocks. I'm sure if there are profits to be found in China, then he's more capable than most of finding them.

However, the trouble with the China story is that the longer-term bull case seems to be based on faith that the authorities can manage the economy in such a way that employment stays high, inflation stays low and growth stays pretty rampant.

For example, the accountant sitting next to me was certain that China was destined for big things in the coming decade. After all, he said, the ruling elites depend so much on continuous economic growth that they're bound to find a way to keep the show on the road.

But this seems optimistic to the point of naivety. Western capitalist economies can't prevent booms and busts. Why are the Chinese likely to prove so much better at it?

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We're not the only sceptics it seems. Markets have been rattled in recent weeks by the prospect of China tightening its monetary policy. The government wants to prevent bubbles from building up – an admirable policy. But the big fear is that they'll tighten too hard, and derail the whole recovery. According to Reuters, a newspaper report warned that "China's efforts to curb bank lending were meeting with mixed success, fuelling fears that policymakers may take more aggressive action soon."

Bringing an economy back down to earth while keeping it ticking along steadily is far easier said than done. As Justin Urquhart Stewart, director at Seven Investment Management, put it: "How do you let the air out of a balloon easily? The answer is with difficulty... there is a level of Chinese uncertainty which hangs as a cloud over us."

What tighter money in China means for you

How should investors react? Teun Draaisma at Morgan Stanley reckons that you should be selling out of cyclical stocks now. "Sell into strength, as authorities have switched from 'all-out stimulus' to 'let's start some stimulus withdrawal.'" He points out that tightening need not necessarily take the form of higher interest rates. It "could be many other things including higher taxes, less spending, more regulation, Chinese/Asian tightening," not to mention Barack Obama's move to tackle the banks.

Looking at various examples from history, Draaisma reckons that we can expect a "serious double-digit dip lasting two quarters or more," with an average 25% stock market correction. As Tracy Alloway on FT Alphaville puts it: "The idea then is to get out of the cheap things – the kind of stuff we saw rally in the 'dash for trash' – and switch into 'strength,' that is, high quality, reliable growth stocks, plus bonds and cash."

Britain's emerged from recession - but keep playing it safe

And this morning, we had more evidence that investors might well be disappointed by growth elsewhere in the world this year. As we note below, Britain emerged from recession in the fourth quarter of 2009 – but only just. Growth came in at a pitiful 0.1%, compared to expectations for 0.4%. As Capital Economics put it: "With household incomes under pressure, credit in short supply and a major fiscal squeeze looming, the path to a full recovery is going to be a long and bumpy one."

That's another good argument for playing it safe. In this week's issue of MoneyWeek, our Roundtable experts pick out some of the stocks that they believe can weather the uncertainty ahead. (You can pick up your first three issues here).

Our recommended article for today

Things are about to get worse for the housing market

In the past 18 months, mortgage interest rates have more than halved. But now they're on their way back up again. Merryn Somerset Webb explains what this means for the housing market.

Comments (7)

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  • 1. Ron

    (26 January 2010, 11:03AM)  Complain about this comment

    Surely what we have now will be a long period of stagnation. A lot of the so called growth came from government services and hotels. Not exactly a real economic swing to medium term growth

  • 2. IJ

    (26 January 2010, 12:48PM)  Complain about this comment

    I don't think anyone who's bullish on China, Anthony Bolton or otherwise, is saying that China can avoid boom and bust. And isn't the bull case based on a lot more than "faith that the authorities can manage the economy in such a way that employment stays high, inflation stays low and growth stays pretty rampant." What about culture, demographics, work ethic, education... I've heard anecdotally that in a class of 10 PHD students in, say, physics or mechanical engineering at top American universities, the breakdown is often about 7 Chinese, 2 Indians and a Russian. Now what if these students, instead of staying in the once prosperous US, decide to ply their trade in their respective homelands as they become more prosperous and prospects start to look better there? I read in the FT today that China now leads the world in scientific research. Surely these kinds of trends - as well as the usual arguments on GDP / capita levels etc - contribute a lot to the China bull case.

  • 3. Ian Chapple

    (26 January 2010, 03:13PM)  Complain about this comment

    You ask why China should be more likely than others to keep its economy on track. Most Western economies are run by Politicians with backgrounds in law, finance, or even more useless occupations. China has many engineers and scientists in the government. Logic may work where political expediency and guess work fail. I would put my money (some of it) on the Chinese.

  • 4. Roger

    (26 January 2010, 03:26PM)  Complain about this comment

    China starts from a low level, average blue collar Chinese worker earns 10% of western workers with much less protection, white collars earns 1/5 to 1/2 of western correspondent. It is this discrepancy within China that keeps the economy dynamic.

    Also, China did experience sever boom and bust 2 times in the last 30 years.

  • 5. JJ

    (26 January 2010, 04:31PM)  Complain about this comment

    I'm sure that no economy can continue up in a straight line without any booms,busts happening but China sure looks better long term than the U.S. or Britain.I also believe the few people running China have to be more qualified to run a country than the average,ignorant,short term greedy voter in the U.S.

  • 6. Kerome

    (26 January 2010, 11:31PM)  Complain about this comment

    It has to be said that the Chinese have one crucial advantage in avoiding boom-and-bust: their leadership is not elected, and so isnot subject to the same pressures that kept the UK government from cooling economic growth and reducing the availability of credit when there was the opportunity to do so. Sustained growth with periodic surges is a posibility.

  • 7. china observer

    (27 January 2010, 04:31AM)  Complain about this comment

    John,

    Perhaps both you and Merryn have been influenced by Jim "Dubai times 1000" Chanos. From the time Deng Xiaoping introduced market reform in 1979 until now, forecasters, writers and analysts have been consistently wrong about China. Despite so many negative remarks that China is on an unsustainable growth path, it simply refuses to role over and have defied the critics again and again.

    If you have time to read, I suggest you to read When China Rules the World by Martin Jacques and China's Megatrends by John Naisbitt and his wife, Doris.

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