In 2014 exports to China
accounted for about 1% of U.S. Gross Domestic Product
(GDP). Yet with all the recent headlines about the
Chinese economy, not a single article we’ve read in the
past few weeks mentions this number, which does not
surprise us.
The investor Leon Levy said that he
was uniquely qualified to analyze the investment markets
since he received an A+ in a college course on abnormal
psychology! As we have often pointed out, we do not
think we can successfully time the market. For that
matter, we feel no one can since the very good long term
returns of stocks are concentrated in a startlingly
small number of days in any given year or decade. Put
another way, if Warren Buffett feels he cannot tap dance
into and out of the market successfully, there is no
reason to think we can either.
In terms of China,
American politicians have been complaining for years
about the lack of Chinese buyers for American goods.
This is, at least for the moment, a good thing. If you
own an investment in a large American seller of bricks,
chocolate, or other goods and services, what goes on in
China or elsewhere is important only insofar as it
impacts the sales, earnings, or cash flows of your
investment. Given the above mentioned 1% of U.S. GDP,
that effect is very limited for most American
businesses. Moreover, consumer spending in China is
remarkably low compared to that in developed countries.
The upshot of this low consumer spending is that China
could have all sorts of economic and financial issues,
but consumer spending could remain resilient given its
low base.
As we look around the world at other
countries, many of them have a far higher percentage of
GDP being generated from exports to China. This is one
reason that we think some of these emerging markets are
toast, at least for now. Of course, the lack of rule of
law, rampant corruption, and centralized control of
economies do not help these emerging markets -- or China
for that matter. For example, a slowdown in China could
be very painful for Chile, where a large part of GDP is
dependent on selling to the Chinese. Therefore, an
investment analysis of any company needs to consider how
much product is getting sold not just to China, but in
places like Chile. A slowdown in China would be very bad
news for a copper or oil producer who has to deal with
lower prices due to reduced Chinese demand, but other
companies might benefit from these lower prices (not to
mention American consumers). If the Chinese currency
goes down, some companies can buy imported goods for
less (e.g. Costco).
We think in the long term
China will do fine economically. However, the eagerness
of wealthy Chinese to move their money to the U.S. and
other developed countries remains startling. To some
extent, that says it all regarding where one should
invest.
The growth in China has been amazing for
many years dating back to the 1970s. A friend of mine
who visited Beijing in the late 1970s said just about
the only car he saw during his time there was the one he
was in – everyone rode bicycles. Today, China is a huge
economy, but one where we think the economic data is
whatever the powers that be decide to invent. There are
quite a few problems with this making up of numbers – a
big one, though, is that is obscures the tremendous
amount of debt that has been taken on in the Chinese
economy to fuel growth.
Nobody really knows what
the Chinese balance sheet really looks like. We think
the Chinese are going to have to work through some tough
financial issues (by the way, U.S. banks’ exposure to
China is less than 1% of assets held in the American
banking system). Again, though, what goes on in the
Chinese financial system is not the key question – we
focus on the outlook for the individual companies we
invest in. That said, we agree with former Treasury
Secretary Paulson, who in 2015 wrote in “Dealing With
China: An Insider Unmasks a New Economic Superpower:”
It is not a question of if, but when, China’s financial system, particularly the trust companies, will face a reckoning and have to contend with a wave of credit losses and debt restructurings. The commercial banks will also have to deal with a higher level of bad debts. That’s the inevitable outcome of economic growth that is too dependent on debt-financed fixed investment in infrastructure, real estate and manufacturing. The issue is how big the losses will be and whether the resulting disruption in the financial market can be kept from spilling into the broader economy.
It is impossible to predict with any certainty the timing or severity or even the immediate cause of a financial crisis.
As Secretary Paulson says, the
when cannot be predicted accurately – perhaps the
Chinese debt reckoning is starting to happen now, maybe
not – nobody knows, including the Chinese. Even if the
debt reckoning for China is starting to happen now,
though, we believe the key to investment performance is
what a company will sell next year and going forward,
and whether the business will earn money from those
sales. Please remember what we have written to you
before – saying you can time the market is saying you
can tell when the five best days will be in each year
going forward – unlikely to happen.
A good
example of how easy it is to be wrong on macro bets can
be seen in a recent New York Times article, “Keynes:
Great Economist, Mediocre Currency Trader.” After
discussing what you’d guess, that Keynes, one of the
greatest macro thinkers of the past hundred years, did
fairly poorly investing based on his macro calls, the
article pointed out that Keynes:
in the 1920s tried to time stock picks. But his returns were low, and he took a big hit in the market crash of 1929. In the 1930s, he shifted toward a long-term approach of buying stocks with good long-term potential and holding them indefinitely … his returns improved.
We do not
like our success to hinge on broad macro calls, because
it is way too easy to get them wrong. In addition, folks
should remember they live in the U.S., not China.
As always, please call or email us with any
questions that you have.