[Editor's Note: This is the latest installment in Money Morning's "Outlook 2010" series, which chronicles global-investing opportunities for the New Year.]
China isn't just leading the global economic recovery – it's lapping the field.
China's gross domestic product (GDP) expanded at an 8.9% annual rate in the third quarter – the fastest pace in a year and up from 7.9% in the second quarter And the median projection of economists surveyed by Bloomberg News is for China's GDP to jump more than 10% in the final three months of 2009, setting the stage for double digit growth in 2010.
China has been the muscle behind the worldwide economic recovery for much of 2009. That role will continue in the New Year as the Red Dragon maintains its catalyst role.
The Organization for Economic Cooperation and Development (OECD) estimates that China's GDP will expand by 10.2% in 2010 – compared to 2.5% in the United States and a paltry 0.9% in the Eurozone.
"The upturn in the major non-OECD economies, especially in Asia and particularly China, is now a well-established source of strength for the more feeble OECD recovery," the OECD said in its 2010 forecast.
Indeed, Beijing's massive $586 billion stimulus program and more than $1 trillion in new lending have helped China overcome a drop in exports and strengthen its domestic market while the rest of the world has struggled. And going forward that strategy will continue to pay off.
"China is the greatest economic growth zone in history," Money Morning Chief Investment Strategist Keith Fitz-Gerald said in an interview, noting the country's economy has increased by a cumulative 371.3% in the last 40 years, an annual average of 9.3%.
Already the world's third-largest economy behind the United States and Japan, China now accounts for 7.5% of the world's total economic activity. It's on track to pass Japan no later than 2010, and may pass the United States by 2020, Fitz-Gerald said.
China's New Consumer Economy
In the past, critics have accused China of being too reliant on exports and its massive manufacturing sector for growth. But the global financial crisis severely damaged the overseas market for exports, which contracted by 15.2% on a year-over-year basis in September. Although that was the slowest rate of decline for any month this year – and was a marked improvement from the 23.4% in August – the statistic still underscores just how weak the market for China's exports continues to be.
But the Red Dragon still found a way to keep its economy humming regardless of this drop in activity. And it did so by investing heavily in infrastructure development, and by stimulating its nascent-but-budding consumer economy.
Chinese banks have lent a record-high $1.27 trillion (8.7 trillion yuan) this year, about 75% of which was doled out in the 2009 first half. That equates to about 50% of the China's total GDP and exceeds the amount of loans extended during all of 2008.
The massive surge in lending has resulted in huge increases in public and private investment, retail sales, and infrastructure development.
Retail sales rose by 15.1% in the year's first three quarters, and urban incomes jumped 9.3%. Incomes increased 8.5% in rural areas. Additionally, fixed-asset investment increased by 33% from a year earlier, and yuan-denominated loans rose to $75.68 billion in September, from $60.1 billion in August.
On top of that, China this year leapfrogged its U.S. rival to become the largest car market in the world. From January to October, a whopping 10.9 million automobiles were sold in China – easily surpassing the United States, where only 8.6 million vehicles were sold.
"The most recent economic data suggests that China's economic recovery is broadening, showing a revival in private real estate investment and a resilient consumer sector," Jing Ulrich, J.P. Morgan Chase & Co.'s (NYSE: JPM) Hong Kong-based managing director, wrote in a recent note to investors. The research note was obtained by CNN.com.
The consumer spending – indeed, the emergence of a whole new consumer class in the world economy – figures to be a major story in the New Year.
"Consumer spending is increasing faster in China than all of Europe and the United States combined," Money Morning's Fitz-Gerald said.
And the "real" story could be even better. The reason: China's GDP numbers may be understated because they fail to account for an additional 3%-5% of economic activity in the service sector, which is essentially a cash economy, Fitz-Gerald says.
"Anyone who has lived in China for a couple of years knows that the service sector is teeming with enterprises (i.e. massage parlors, restaurants, hair salons, etc.) which trade on cash. These are far from adequately reflected in the calculation of the GDP figure," he said.
An Exemplary Exit Strategy
Now that Beijing's policymakers have achieved the level of economic growth they sought at the year's outset, the central government it's starting to wean the country off of state support. But that doesn't mean the lending spigot will be shut off.
Banks in China are still expected to lend between $1.17 trillion and $1.32 trillion (8 trillion yuan to 9 trillion yuan) in 2010, a relatively slight decrease from this year's likely new-loan total of $1.46 trillion (10 trillion yuan), China's Bank of Communications (BoCom) said last week.
Chinese banks will also lend more efficiently in 2010, because the People's Bank of China (BOC) – the country's central bank – has called for stricter supervision of bank loans to prevent stimulus spending from being directed toward wasteful government projects. The central bank has also taken steps to lower risk by ordering Chinese banks to raise their bad-loan reserve ratios by the end of the year.
Additionally, even if lending is curtailed, China's biggest challenge isn't a lack of liquidity; it's getting spurring its thrifty populace to spend.
"The problem in China is a savings rate of 35% and not enough spending," said Fitz-Gerald. "The short-term and long-term challenges are the same – to get people to spend more."
Still, that's a relatively easy problem to fix, whereas officials in the United States right now face a far more difficult situation.
"In the United States, the Federal Reserve and policymakers are faced with conflicting goals," said Fitz-Gerald. "They need people to spend in order to get the economy rolling again, but their end game is to have the American people spend less and save more."
All told, though, the Chinese economic growth machine is firing on all cylinders.
Domestic consumption, the rise of the service sector and increased private investment won't make China immune to economic stresses. But the overwhelming strength of an economy with 1.3 billion consumers – 300 million of them part of the zooming middle class – will help insulate China from global volatility and keep the economy humming.
In fact, China is using the financial crisis as opportunity to leverage its position and to emerge as a central player on the world economic stage. China's GDP growth will hit double digits in 2010, while U.S. growth languishes in the 1%-2% range.
Riding the Red Dragon
China's astonishing growth grants unprecedented growth and profit potential to companies with a strong connection to that market. Individual investors have that same opportunity. China's economy is a juggernaut that will eventually surpass the United States, and savvy investors should allocate their portfolios accordingly.
"Those who fight the inevitable tide of China will be like salmon swimming upstream — not many make it," said Fitz-Gerald. "Eventually, all roads will lead to China."
There are several ways investors can increase their exposure to the Chinese investment landscape, starting with well-diversified mutual funds, including large multinational players, and ultimately ending with direct investments into Chinese-based companies.
Conservative investors may want to look at the U.S. Investors China Region Fund (MUTF: USCOX). The fund spreads its investments around one of the world's fastest-growing regions with holdings in enterprises registered and operating in China and the China region.
The fund is operated by the San Antonio-based U.S. Global Investors Inc. (Nasdaq: GROW). At least 80% of the fund's assets are invested in equity securities and depository receipts of companies located in the China region. The fund also invests in securities that trade directly on the Hong Kong, Shenzhen, and Shanghai stock exchanges, as well as others that are listed on the Taiwan, Korea, Singapore, Malaysia and Indonesia stock exchanges. The fund is up more than 37% year to date, and annualized five year returns have averaged 10.5%.
Beijing will spend more than $400 billion on infrastructure by the end of 2010, and lots of that will go to building rail lines, including a $17.6 billion passenger rail line across the deserts of northwest China, a $22 billion web of freight rail lines in the Shanxi province and a $24 billion high-speed passenger rail line from Beijing to Guangzhou.
It takes lots of steel to build railways and you can't produce steel without iron ore. In order to ride along, take a look at multinational Vale SA (NYSE ADR: VALE), the largest iron ore producer in the world.
The Brazilian company is a key supplier to China's exuberant infrastructure growth, and a true play on the global commodities market. With a historical Price/Earnings (P/E) ratio of about 15, Vale will benefit hugely from further run-ups in the price of iron ore and no one uses more of it than China.
As China's exploding middle class saves 35% of every dollar they earn, they're sopping up life, health and other insurance products at record rates. China Life Insurance Ltd. (NYSE ADR: LFC) enjoys preeminent insider status as state-owned life insurer. China Life has a 40% share of the market, the lowest cost of funding in the world, and gives investors a direct play on China's skyrocketing GDP.
[Editor's Note: Money Morning's "Outlook 2010" series has already provided readers with a forecast for the U.S. economy in the New Year. Coming up next week will be a report on the outlook for oil and energy. Watch for future installments addressing the economic outlook for the high-tech sector, retailing, foreign investments and other key topics.]
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