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The Changing Fortunes of China

As staunch believers in broad diversification, our investment approach routinely incorporates a number of emerging market asset classes within our managed portfolios. In contrast to the world’s developed markets—like the U.S., Germany, France and the UK—underdeveloped countries generally are still transitioning to a free-market oriented economy. These markets can be more volatile and generally riskier due to ongoing political and economic reforms, but are also anticipated to deliver higher returns because of much higher growth rates.

The “800-pound gorilla” of these emerging markets is China, as it currently represents slightly more than 20% of the asset class. As the world’s most populous nation, with over 1.4 billion inhabitants, it also has one of the fastest growing economies. China is now the world’s second largest economy, having overtaken Japan in 2011. Economists predict China will grow by 7% to 9% annually over the next few years. In contrast, the U.S. is expected to grow by 3%, while growth in Europe and the UK is estimated at less than 2%.

Before the turn of the century, China’s primary contribution to the global economy was manufacturing, making it heavily dependent on exports for economic growth. However, thanks to the ongoing migration of its rural population into urban areas along with its growing middle class, China’s economy is now increasingly driven by consumer spending. This growing consumer demand has benefited China’s corporate world which now must meet this demand.

Similar to the rest of the world, Chinese stocks plummeted during the 2008-2009 financial crises. After posting a record high of 6,092 points in October 2007, the Shanghai Stock Exchange Composite proceeded to lose more than two-thirds of its value by late 2008. As China relies heavily on exports, the difficulties experienced in Europe and the U.S. during their respective meltdowns proved particularly painful. Recently, Chinese stocks have been hurt by the anemic economic turnarounds experienced by the world’s developed markets and, to some extent, by the investing public’s lack of enthusiasm after the downturn. Investment from outside the country is also limited, as foreign investors cannot purchase many domestic shares.

While concerns abound with respect to the future direction of the Chinese economy and stock market, we see some key changes taking place which will keep the economic growth rate at current lofty levels. Recent moves by policy makers in the year after President Xi Jinping came to power have strengthened investor protections and corporate disclosure requirements. Also, a number of key administration officials have pledged that new regulations will be enacted to provide more foreign investment. We remain cautious over the risks involved, but feel such a large and growing market should provide good opportunities for the U.S.-based investor going forward.

 

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