Cashing in on China (part two)

Jennifer Schonberger | Apr 14, 2008 6:20am EDT | Comment

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Last Friday we brought you Chinese stock guru Jim Trippon’s thoughts on investment ideas in China and the outlook for the Chinese stock market (see http://www.smallcapinvestor.com/articles/04112008-cashing_in_on_china). Today, Trippon examines the larger economic picture, the future of China and how it will affect the U.S. economy.

Trippon, editor in chief of the newsletter China Stock Digest, runs the largest equity investment research firm in mainland China and advises corporate pensions, private trusts, and high-net-worth families on their China investment strategies. Trippon spoke with SmallCapInvestor.com’s Jennifer Schonberger last week.

“Chinese stocks have been a phenomenal alternative to U.S. stocks over the last three years. In 2006 we made a 39% return and last year we made over a 58% return in a year that was mediocre for the U.S. market. Although there is a linkage between the U.S. market and China’s stock market in the short term, when you begin looking over longer periods, our economies could not be going in more different directions. You’re seeing the end of the dollar as the world’s currency, you’re seeing the end of the United States as the world’s largest economy and, at the same time, you’re seeing the rise of China to replace both.

“It’s played out a lot because of our trade policies. China’s impact on the United States has actually contributed to our low cost of living by giving us consumer products at manufacturing costs that we could not duplicate here. Even if labor rates rise overseas, they’re not going to bring those parts back here. There’s no way that’s going to shift when the average auto worker in Detroit makes $50 an hour including benefits and the average worker in China makes $5 a day including benefits. It’s a mixed bag in that it’s good for the U.S. consumer to be able to buy cheap consumer products that cost less than they would have if they were manufactured here, but it’s arguably bad for our society to no longer have a middle class that’s viable.

“[China] is not too dependent on exports. For the past 30 years the country has been very dependent on exports and still is — [exports] are half of their economy, but each year it’s a lower percentage. That has a lot to do with the fact that not only have we exported our manufacturing business to China, but arguably we’ve exported our middle class as well, so you see a shrinking middle class in the United States. In China, you have a business phenomenon being created by this: the creation of a middle class. As the middle class grows in China they’re buying a lot of those products that were once exported. That’s why, for example, China is now the world’s second-largest car market to the United States, as measured by cars purchased by the local population. It’ just one indication of the fact that they’re becoming less dependent on exports.

“The second point is that last year, the United States was no longer the largest export market for China; now it’s the European Union, which is one more sign that the end of world wide U.S. economic dominance is upon us. Certainly within the next 10 [years] China’s GDP will be higher than ours. You will see the Yuan continue to appreciate. Exports will be damaged by a prolonged recession in the United States — so what does that mean for China? That means the country’s growth rate will drop from 11.9% last year down to 8% this year, which is still four- or five-times higher than what we’re going to experience here, so it’s a good place to be.

“Going forward, I think that the long-term impact is going to be that you’re going to see a continued polarization of wealth in the United States. I think 100 years from now the United States is not going to be in poverty, but is going to look more like the United Kingdom than the United States. If you go to London today and want to buy a condo in the downtown area, it’s a lot more expensive than it is in Manhattan. You have a huge working-poor class and a small affluent elite class in the United Kingdom and I think that’s what you’re going to see in the United States.

“I think [Chinese companies funneling money into U.S. IPOs and companies is] a sign of [China’s] emergence into a world economic power, and we’re going to see a lot of this from Europe as well. It’s also a sign of the weakness of the U.S. dollar. If you can come into the United States and buy companies at low valuations with a strong currency, it makes it that much cheaper for them to do so. An example would be when China’s Lenovo came in and bought IBM’s (NYSE:IBM) PC division. It gave [IBM] a distribution mechanism so not only would they be a cheap contract manufacturer, but they’d also be able to take the risk from the retail pricing and pick that up as well. It’s no different than what you saw Valero (NYSE:VLO) do in the United States when they bought all the Stop ‘n Gos. Valero didn’t want to be the wholesale refiner, they wanted to pick up the profit from the retail end as well. That’s what you’re going to see more and more Chinese companies do as they get wealthier. They’re not going to just want to do the low dollar manufacturing. They’re also going to want the retail profit because that’s where a lot of the gain is and you’re going to see more and more of that.

“India and China are the two large developing countries with large populations. Certainly China and India compete with each other for economic opportunities. Although a lot of people see India as a huge threat to China, I don’t see it because of two things: first, India’s economy is only about 40% of the size of China’s even though the populations are roughly the same. Secondly, I don’t see India as a manufacturing threat to China primarily because of India’s lack of transportation infrastructure. India doesn’t have a workable road system. It does not have a workable rail system. That’s why a lot of times their agriculture products rot in the field rather than making it to market. In China, on the other hand, there’s a world class rail system that allows products to be manufactured at low cost and put on the shelves in Shanghai and the United States. It’s a totally different situation that allows China to have manufacturing that India can’t compete with and that’s the big difference.

“We’re only about 20% to 25% into [experiencing the China wave]. I think now we’re finally starting to wake up to it. The impact on the U.S. economy and the impact on U.S. society is mostly in the future and we’re barely scratching the surface of it. With every global shift there’s going to be a beneficiary and a victim — find a way to exploit that demographic shift. I don’t think the United States will be the land of opportunity 200 years from now.”