Kipling wasn’t alone in seemingly losing his sense of direction in the face of the exotic excitements of emerging markets. Economists who are sceptical about the developed world have accepted uncritically the idea that faster-growing developing economies must be good investments. They can be, but it’s not that simple. China in particular – the biggest emerging economy, and nowadays the biggest emerging equity market too – may be a more attractive investment if it grows more slowly than it has.
Most people live in emerging markets, so in an increasingly-integrated world, it makes sense to think that most market capitalisation eventually will too. Unfortunately, this argument applies only on a very long-term view (and is no guarantee of good investment returns even then). China, for example, has grown 7% per annum faster in real terms than the US since 1996, yet its stock market has underperformed the S&P500 by an average 5% per annum. The emerging world as a whole has grown 3% per annum faster than the developed world over the same period, and has contributed most to global growth (a mostly home-made, not export-driven, contribution). But that contribution has not done it much good: its roller-coaster stock market performance has left it where it started in relative terms.
Slower growth in China, and attendant worries about internal debt and its shadow banking sector, have unsettled many. China is a big country, and its numbers can be scary if presented out of context – which many instant experts are only too happy to do. Its empty new towns look alarming, its investment is hugely inefficient, and its pollution is daunting (London’s recent smog literally pales into insignificance by comparison with the norm in Beijing or even Hong Kong). Our view remains however that the slowdown underway is manageable; we think China’s consolidated balance sheet is sound; and while we do not admire the regime, we recognise that it is both able and willing to act decisively if needed.
China has been a poor investment to date largely because corporate earnings have not grown anywhere near as quickly as its GDP might have suggested. But if its government succeeds in making market forces play a more “decisive” role – by not, for example, interfering in the setting of prices, or the direction of fixed investment and bank lending – then China’s structural slowdown could coincide with better stock market performance. There may be less prospective GDP growth ahead, but if more of it makes its way to the corporate bottom line it could be more valuable to investors.
And China, like emerging markets generally, has been looking relatively inexpensive. We have been sitting on the fence, waiting for more developed-world monetary normalisation to be priced-in before turning more positive. But markets may not be so patient.