Emerging-markets roundtable: Part 2

China faces challenge of slower GDP growth.

Sonita Horvitch 14 December, 2011 | 7:00PM
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Editor's note: In today's second instalment of Morningstar's emerging-markets roundtable, our trio of portfolio managers debates the growth prospects for China and India, the world's two most populous countries.

The panellists:

 Patricia Perez-Coutts, senior vice-president and portfolio manager at AGF Investments Inc., and manager of the award-winning AGF Emerging Markets;

 Chuk Wong, vice-president and portfolio manager at Goodman & Co. Investment Counsel Ltd., which manages the Dynamic mutual funds. Wong is a global manager with an extensive knowledge of emerging markets, and among his various mandates are Dynamic Far East Value and Dynamic Global Value;

Boston-based Chris Arbuthnot, senior managing director and senior portfolio manager at Manulife Asset Management Ltd. Arbuthnot is also a global manager with an expertise in emerging markets. His mandates include Manulife Global Opportunities.

They spoke to Morningstar columnist Sonita Horvitch, whose three-part series began on Monday and concludes on Friday.

Q: Time to talk more about China.

Wong: The golden era is over. Over the last 10 years, the country had a high GDP growth of 10.7% on average a year and low inflation of an annual average of around 2.2%. In the next decade, China will have a lower GDP growth of around 7% to 8% a year and a moderately high inflation of 4% to 5% a year. Longer-term, this is healthy. The growth is higher quality and is more sustainable.

Chris Arbuthnot

I just came back from China recently and the major concern there now is about the collapsing European demand and about the U.S. economy stalling. They are not that concerned about domestic issues. Yet, North Americans are worried about China's banking system and its housing market. I think that these issues are manageable.

Q: Chris, you have been skeptical about China. You have a low exposure to China-based companies in Manulife Global Opportunities.

Arbuthnot: This reflects my lack of enthusiasm about management teams and some companies in China. But, I do believe that this non-performing-loan issue could be huge. I am also concerned about the sustainability of real-estate prices. A lot of Chinese store their wealth in real estate.

Wong: Yes.

Arbuthnot: There is considerable overcapacity in the economy.

Wong: I don't think that any economy can have a perfect supply-demand match. The demand side in China is going to be very strong, despite lower overall growth. On housing prices, in the last five years, they have gone up too fast and are too high. The average person finds it difficult to buy a home. When housing prices correct, people will buy. The correction in the housing market so far is being engineered by Beijing.

Perez-Coutts: I'm in Chuk's camp. The problem is confined to four or five cities. Major cities such as Beijing, Shanghai and Shenzhen have seen their house prices move far higher. In the smaller cities, you have not seen these massive price increases. Beijing has successfully engineered lower house prices before.

Q: What of China's banks and non-performing loans?

Chuk Wong, Patricia Perez-Coutts and Chris Arbuthnot

Perez-Coutts: There has been some off-balance-sheet financing. There is some rescuing to be done in the case of some municipalities. But it has been caught early. Most people talk about Wenzhou, which is south of Shanghai, where borrowers have defaulted on their debts.

Chuk: Wenzhou is known because it's the first city that was opened up and it has a lot of risk-takers. It is the exception. It must also be remembered that the Chinese housing bubble, if it is a bubble, is not leveraged.

Arbuthnot: But generations of savings are going into these houses. My colleagues in Beijing point this out to me and say this is an issue, even though the housing market is not leveraged.

Q: Can we sum up on China?

Wong: China is not going to collapse tomorrow and it's not going to be as bullish as some of the local Chinese investors think. There are some real challenges, but you have to ask if they are manageable? I don't think that a hard landing is a scenario.

Perez-Coutts: China's GDP growth prospects are somewhere between 7% and 8%. Inflation at 4% or 5% seems to be the right number for the next two to three years. There will be no hard landing.

Q: India?

Arbuthnot: I remain bullish on India.

Perez-Coutts: I am positive on India.

Arbuthnot: Nothing that has happened this year derails the medium- to long-term story. Higher inflation this year has caused India to be aggressive on interest rates and produced a weaker GDP than expected. It could be in the region of 7%. Earnings revisions have been negative, which is not favourable for stocks. There is a lot of negative sentiment. You meet with Indian companies and things are not as robust as they were a year ago.

If you fast-forward another six months, inflation in India will come down and there could be scope to lower interest rates. The demographics in India are favourable, with 42% of the population less than 15 years old, so you will add 140 million to the working population in the next 10 years. It's easy to see how GDP per capita, which is at a low level, will triple in the next eight to 10 years. Also, you have very good management teams. With the high insider ownership and the high interest rates, capital allocation tends, for the most part, to be disciplined, similar to Brazil.

Chuk Wong

Perez-Coutts: I am most enthusiastic about India. I have 10% of my holdings in AGF Emerging Markets in India. I have about 17% in China. India can grow its GDP by 7% or 8%, as can China. Of India, the country has more pervasive inflation than China. India lacks infrastructure and this is causing the country to be more prone to these bouts of inflation.

Arbuthnot: I agree.

Perez-Coutts: The problem is that the central bank has never been ahead of the curve on inflation. Also, the government has also not sufficiently encouraged foreign direct investment and therefore more infrastructure spending. On the companies themselves, a note of caution, while many are return-oriented, some owner-managers of conglomerates have made ill timed and badly focused acquisitions in the past two years. For example, the TATA Group bought Jaguar and Land Rover, two British car brands. Many of these acquisitions are not return-driven.

Wong: In both India and Brazil, a few large companies are very prominent in the economy. These companies have pricing power. That is attractive. But, I am a value manager and, as I have always said, Indian stocks are not cheap.

Q: Other countries in Asia of interest?

Perez-Coutts: I have about 5% in Thailand; the yields on these companies save the day. Indonesian stocks are expensive, but the economy offers a balance between natural-resource production and growing consumption. We have about 4% in Indonesia in AGF Emerging Markets. Like India, it has an important democratic dividend, which is a plus longer-term. We have about 5% in Taiwan with a focus on the technology sector. The Taiwanese economy is deriving its impetus from China. South Korea is practically a developed country. We own the electronics giant Samsung.

Wong: I like Indonesia. It has a democratic dividend like India, but it has a much higher literacy rate at 91%. Indonesia has natural resources, unlike India. Thailand is always under-appreciated. The economy has held up well despite the political uncertainty and the natural disaster. I like South Korean companies, but I am concerned about the North Korean risk.

Photos: www.paullawrencephotography.com

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Sonita Horvitch

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