Morningstar Advisor - December/January 2012 - (Page 48)

Spotlight Challenges Ahead: China faces a host of potential problems that could derail its growth. Fund managers are pinning their hopes on China overcoming these challenges over the long term. Issues What Bulls Say What Bears Say policymakers will relax their tightening stance so quickly, even though headline inflation has likely peaked because of base effect. As for the property market, he does not see the bubble to bursting in China. “The underlying demand in China is still very strong for the secular urbanization trend. Overall, we believe that the Chinese economy is still on a good growth path with this year’s expected GDP at 9% and next year at 8.5%. The transition to a more consumptiondriven economy is underway. However, this will take time.” Jan Ehrhardt, managing director, DJE Kapital AG, Pullach/Munich, and fund manager, DJE Asian High Dividend Runaway Inflation Inflation rates have peaked and governments will move to more expansionary policies. Inflation rates appear artificially high because of the spike in recent food prices because of unexpected weather conditions and high energy prices, which are expected to fall. Risk of stagflation because of slowing exports and increasing wages. Vicious cycle of wages chasing prices and prices chasing wages has begun. Inflation and capital controls make China uncompetitive versus other emerging-markets countries. High interest rates will force smaller property developers to liquidate their inventory to meet loan obligations. The pace of property price increases (up to 800% in some cities) is indicative of a bubble. The lack of free-flowing capital markets has led to high interest rates, which is stifling growth. High interest rates will sooner or later lead to high default rates among borrowers. The sheer size of the unregulated lending market poses a risk to the economy. China is still an export/manufacturing-driven economy and the slowdown in global economic growth poses a serious threat to China’s future growth. Property Bubble Underlying structural demand is strong because of urbanization. Loan/value ratios on mortgages are much lower than those in the U.S. Chinese regulators have been active in cooling property prices. Shadow Banking System There is little systemic risk as there is no new money being created. The size of the market is difficult to estimate, and gearing levels are much lower than those in the U.S. The shadow banking system has always been a part of the Chinese economic system. Declining Exports Domestic consumptions is growing and the country is now less reliant on exports. More than 50% of Chinese exports are going to emerging-markets countries. Ehrhardt thinks that although restrictive monetary policy is hindering the economic development of China, he is optimistic about the country’s growth prospects. He worries that many small property developers are taking very high interest loans from the shadow banking system, and they could be forced to liquidate their properties at lower prices if the property market slows down— although he admits that the situation is not the same as in the United States, because of the much lower mortgage loan/value ratios. “In general, China’s growth in the last few years stemmed from financial investments. This will shift towards more domestic consumption in the future. This already is evidenced by the growth in the retail sector in China of 17.7% in September. All in all, I do not see any signs of stagflation down the road. Chinese stocks and shares from Hong Kong, in my opinion, offer medium and long term the greatest opportunities in Asia.” He further postulates that if the inflation rate falls below 5% in 2012, monetary policy should become expansionary again. K Sunny Ng, CFA, is director of fund research with Morningstar Asia. Stock Valuations The market is pricing in a worst-case The low current valuations are a scenario for the Chinese economy. reflection of the many economic challenges that China faces. Valuations of metrics such as P/B and P/E are below 2008 and 2009 crisis levels. “Current market valuation at 8 times forward earnings and 1.3 times forward book value certainly looks appealing on the longer-term investment horizon. Going forward, easing inflationary pressure as well as softening economic activities would prompt the central government in fine-tuning its policies and make necessary adjustments by various degree to maintain reasonable growth for China.” Grant Yun Cheng, head of emerging markets, Union Investment Privatfonds GmbH Cheng believes that although the recent economic data in China indicates that the economy is cooling off, he does not foresee a “hard landing.” He notes that both domestic consumption and industrial production is proving to be very resilient. On the issue of inflation, he does not believe that the 48 Morningstar Advisor December/January 2012

Table of Contents for the Digital Edition of Morningstar Advisor - December/January 2012

Morningstar Advisor - December/January 2012
Contents
Contributors
Letter From the Editor
Seduced by Complexity
Is China Exposure Important for a Portfolio?
A Niche Built on Trust
How to Find Your Client’s Investment Style
Taking the Long View
Consensus on Europe Elusive
Four Picks for the Present
Investment Briefs
Is Perception Reality for Active Managers?
Be Alert for Basic-Materials Bargains
Investment Boom Unsustainable
Digging Moats in China
Where China’s Domestic Companies Stand to Benefit
Arising Opportunities
China Strong Long Term
From Currency Manipulation to International Acceptance
The Keys to China’s Fortune
Wedgewood’s Lessons Pay Off
Reading the Evidence on Indexing
Scouting for Investments Abroad
Yield, Please (Hold the Europe)
Mutual Fund Analyst Picks
50 Most Popular ETFs
Undervalued Stocks With Wide Moats
China Fund Managers Eat Elsewhere

Morningstar Advisor - December/January 2012