The truth about China – end of the road or only just begun?

Last month we looked at the US economy and how the road ahead is much more a political problem than an economic.  Whilst the US is coping plenty of press about the issues it faces we remain quite relaxed about its prospects both domestically and, more importantly as a source of quality investment opportunities.

This month I promised a look at the other media favourite – China.

Developing Asia and in particular China, has been a strong investment theme for us for many years now, before during and even after the “GFC”.  Whilst there’s been no shortage of Chinese doomsayers during this period, the Chinese economy has continued to defy its critics with continued strong performance almost regardless of the broader economic fortunes.

But Chinese economic growth numbers aren’t real?

There’s a general perception that the Chinese government tend to make up the numbers they want as opposed to reflecting what’s actually been measured.  Any long-term follower of my various rants over the years would appreciate that to some degree every country’s “official” economic numbers are a bit wrong so we tend not to put all our faith in anyone’s “official” numbers.

Verification

In a previous life\misspent youth I managed pubs and nightclubs and in that industry the best source of information on your competitor’s fortunes was the Coca Cola sales rep.  Why? Quite simply whilst there were two major beer companies and a number of suppliers for spirits but everyone served soft drink and Coke was by far the major player.  You could tell the relative fortunes of any pub simply by the amount of Coke Post mix they were buying.  Coke was the best “base input” for gauging bars.

Similarly I remember talking to a top rated analyst at a major funds management business many years ago about how they conducted their research.  Their long-term performance was not only exceptional but remarkably consistent and I was curious to understand how.  The example he gave me was Sony.  At the time Nintendo had the Nintendo 64 game console, a technologically superior device to the Sony Playstation.

Apparently Nintendo had in fact developed the platform for the Playstation (32 bit) and in doing so discovered they could quickly develop a superior 64 bit version.  They decided to sell the inferior 32 bit version to Sony with a view to trumping them soon after with a superior technology.  Despite the inferior technology, Sony Playstation significantly outsold the Nintendo 64 and was the standout market leader.

The next generation of consoles were soon due (Nintendo Gamecube vs Playstation 3) and Sony had reportedly spent an obscene amount of money developing the PS3.  Consequently much of Sony’s future was dependent on the success of the PS3 and as such its sales prospects were a significant input into trying to value Sony as a company.

So where did the analyst turn to?  Well naturally he spoke with Sony’s management about the efforts they had gone to and they’re market research for projected sales.  He also spoke with major competitors at Microsoft (Xbox) and Nintendo to see how worried they were.  He considered this information relatively insignificant however in forming his ultimate views.  Instead he turned the bulk of his attention to Harvey Norman.  Why?  That’s where the sales would be made.  He was more interested in the views of the purchasing managers at Harvey Norman because they had the best idea how much hype and pre-orders there were and they would be the first to see the sales trend to the end consumer.

This reminded me of my experience with Coke and reinforced the idea the real source of truth isn’t always what you might first think.

So what’s a good indicator?

When it comes to economic growth there are a few (GDP isn’t a great one), however let’s look at what makes a good measure.  Ideally we’d want something we can;

• Measure what’s going in so we can get information from sources other than the user (like Coke)
• Compare with other economies– i.e. other countries use for largely the same purposes
• Track usage changes over time relative to economic growth
• Track historical usage of developed economies to see how they were at similar stages – i.e. we have meaningful comparative history

If we could get some way of measuring this, it would be a powerful indicator of where a country like China is on the development path.

There are such measures!

From this graph it appears China is following a well established path to industrialisation and is barely half way there.  Whilst much of the last 15 years has gone into buildings and infrastructure, the experience of other economies shows that even as this slows, total consumption continues to grow as cars, airconditioners and microwaves take over.

When you consider the sheer size of the Chinese population, some 1.4 Billion, you start to get a sense of the scale of the road ahead. Oh, and then there’s India, another 1+ Billion heading down the same path, albeit at a slightly slower pace.

Given this future and in keeping with this month’s music inspired headlines – You ain’t seen nothin’ yet….

July: The Truth about the Australian Sharemarket outperformance- 2000-2010