In a recent investment note, Bathgate explained that the caveats required to support investing in Chinese companies were so numerous that the few remaining worthwhile options were victim to overly inflated share prices.
China could no longer be categorised as similar to India or Thailand as it embarks on a seemingly deliberate progression from a low-cost manufacturing nation to a higher value producer of goods and services with an appreciating currency, he said.
Annual expansion of 10% for the last two decades alongside rising standards of living meant China’s role as a low-cost manufacturer with an endless supply of low-paid unskilled workers was coming to an end, the note pointed out.
With the associated reduction in its growth forecasts, Bathgate said the alleged 'hard landing' might be better described as “a managed transition from a high-octane emerging market economic model to a more sustainable developed market structure.”
Regarding the looming property bubble, Bathgate said it only presented a problem if the country could not afford it, with the boom, having served its purpose of keeping the global economy afloat, now being gradually unwound by the government, as reflected in declining commodity prices.
As China graduated to have a more developed-market-like status, where the majority of economic growth was derived from internal consumption, stock selection needed to come with a few health warnings.
“First, China’s transition is happening right now and therefore any projections are being made in a rapidly changing environment. Conventional investment theory tells us that stock prices are the total of all future estimated earnings, and if those estimates turn out to be wrong then the price paid will be wrong.
“Correctly valuing a stock in a country where the annual growth rate hasn’t dipped below 7.6% since 1990 is fraught with dangers of over extrapolating growth trends into the future.”
In addition, governance remained an issue, with many of the large and successful businesses still state-owned enterprises and were raising capital through repeated new share issuance, which significantly dilutes shareholder interests.
For the remaining opportunities – companies that are independently owned, not diluted shareholder interest and fundamentally sound businesses – their share prices were vastly overinflated.
“Essentially, there are countries queuing up to take China’s place as low-cost manufacturing hubs, while China itself will become more like the US in terms of its effect on the wider world, creating investment opportunities around the globe because of the sheer power of its internal consumption.”
