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Pessimistic on Short-term, Optimistic on Long-term

Sigma Investment Counselors

October 3, 2012

Recently released data showing that the growth in China has slowed is raising concern for its once fast-growing economy.
China has long relied on exportsto fuel their growth. Exports generated 31% of GDP in 2011, according to World Bank data, and support an estimated 200 million jobs – around a quarter of the country’s workforce. Growth in exportshas fallen since the beginning of this year due to the recession in Europe and a slow economic recovery in the US. August’s growth slumped to 2.7% compared with the rate a year ago. It fell short of analysts’ expectations and was well below the double-digit growth rates of the last three years.

The China Manufacturing Purchasing Managers’ Index released by HSBC showed overall factory activity shrank for an 11th consecutive month in September, despite the 47.9 index level being slightly higher than the August reading of 47.6. (A score above 50 indicates an expansion in manufacturing activity and below 50 indicates a contraction.) Chinese industrial companies profits declined by 6.2% year-over-year in August, making its fifth consecutive monthly drop. The lower profits may continue to drag down entrepreneurs’ confidence and suppress industrial operations in the near future.

Beijing is well aware of these issues and has sped up actions to stimulate the economy. The Chinese Central Bank has cut interest rates twice since June and eased the bank reserve requirements, freeing up about $190 billion for lending. The government has already announced $150 billion worth of stimulus funds to be spent on various infrastructure projects. But, so far, the stimulus measures have not lifted the broader economy. Analysts expect 2012 to be China’s weakest full year of growth since 1999 at just 7.7%.

With all that being said, I am still optimistic about the medium- to long–term outlook for China and believe the current rough patch is just a footnote to China’s growth story. Here are the reasons.

First, China’s liquidity situation is relatively healthy. Chinese save far more than Americans. There is a huge pool of personal savings for Chinese consumers to spend. The average household savings rate in China was 38% in 2010, compared with just 3.9% for Americans, according to research conducted by Bloomberg. Meanwhile, the household consumption in China accounted for only 35% of the overall economy in 2010, vs. 71% for Americans.

Second, the longer-term trends of increased urbanization and industrialization in China are still in place. It is estimated that 200 million people will migrate from rural China to its urban centers over the next 20 years, which should be bullish for residential real estate.

Lastly, the Chinese government can also remove home buying restrictions to stimulate economic activity. The Chinese government has tried to discourage real estate speculation by restricting excessive housing purchases. But people have the money to make these investments. Should the housing market sink, the government could easily remove those restrictions to ease the pain for the short term. Of course, we should be aware of the side effect of removing those restrictions – possible housing bubbles.

Any questions or comments are welcome.

Wenma Gorman, CFA

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