Burton Malkiel, the Princeton professor, author of the seminal “Random Walk Down Wall Street,” and the champion of index investing, is bullish on China. In a speech Wednesday night at the New York Stock Exchange, hosted by Guggenheim Investments, Malkiel laid out his case for why China will continue its rapid economic growth, argued that most investors are underweight China, and suggested ways to invest in China.
Beginning by contrasting the American and Chinese economies, Malkiel said that “I’m not negative on the U.S.,” that “my guess is there will be no double dip” recession, and that while he expects “some GDP recovery” in the third quarter, the U.S. economy “will remain sluggish.” Over the longer term, however, he argues that “too much debt is associated with poor economic growth.”
“We’re over-indebted,” Malkiel (left) said, pointing out that before the housing bubble, American consumers had $0.33 of debt for every $1 in income, but that after the bubble, “we’re at $1.33 of debt for every dollar of income.” The anemic pace of housing starts, he suggested, is “unlikely to change soon,” and that American financial institutions “still need to deleverage and recapitalize.” Looking at the overall growth and indebtedness of developed countries, he noted the 100% ratio in the U.S. of debt to GDP, developed Europe’s similar levels of indebtedness and that “Japan is a basket case” at 150% debt to GDP.
Among developing countries, that ratio stands at 60% for India and Brazil, but only 16% for China. “That’s why I’m enthusiastic about China,” he said bluntly. As for economic growth forecasts, he admitted that China “may not make” the 9.6% growth that the IMF has predicted for China in 2011, but forecast 7% to 8% growth for China from 2012 to 2014. “I’ve always been wrong on forecasting China” economic growth, he said. “I’ve been too pessimistic.”
One of his main reasons for forecasting continue growth in China is because, he said, “all the growth so far has been in the east of the country,” including the capital of Beijing and Shanghai, while the center and west of the country is “undeveloped and dirt poor.” It’s also where there is considerable social unrest, he admitted.
From a practical viewpoint, the Chinese government needs growth to continue in the central and western parts of the county so it can stay in power. “The government knows exactly what it’s doing with its infrastructure investments” and said that the Communist Party leadership will be successful because of the Chinese culture that “reveres education,” has a strong work ethic and is entrepreneurial. He called the late Chinese leader Deng Xiopeng “remarkable,” saying he “unleashed” the power of this Chinese culture that has resulted in China’s unprecedented growth.
“We’re in the middle innings” of China’s outsized growth, which he expects to continue for the next two decades, partly because internal consumer consumption accounts for such a small part of China’s export-driven economy. In the U.S., consumption accounts for 70% of GDP and only 35% in China, which will likely grow as development increases in those central and western parts of the country.
Investing in China
As for investing in the country to take advantage of its growth prospects, Malkiel said “most investors are underweighted in China, and that he “thinks a 9% to 12% weighting is right.”
He pointed out two of the many attractive ways to take advantage of Chinese growth. Chinese equities, he said, are “entirely reasonable investments” and that in the seven to eight years that he’s been extensively covering investing in China, “I’ve never seen such attractive valuations.” He then took a moment to blow his own index horn that his firm Alpha Shares has created, the Alpha Shares China All Cap index. Guggenheim has licensed that index to create the Guggenheim China All-Cap ETF, ticker YAO.
The second interesting vehicle would be yuan-denominated “dim sum” bonds. A two-year duration Chinese government or agency dim sum bond is paying 1% now, he said, and with the expected 5% annual appreciation of the Chinese currency, “you’ll get 5.5% to 7%” from those Hong Kong-issued bonds.
Responding to a questioner on the possible political dangers of investing in China, he said that the Arab Spring “scared the daylights” out of the Chinese leadership. And while China is different from many of those Arab Spring countries where a small elite ran the countries, noting that there are 80 million members of the Communist Party in China, that fear is one more reason why the leadership is “hell-bent on keeping the growth engine growing.”
Answering another audience question on the Chinese currency itself, he said that while in March 2009 the Chinese government called for the yuan to replace the U.S. dollar as a reserve currency, he acknowledged a broad consensus exists that the currency is undervalued, and its chances of replacing the dollar as the world’s reserve currency “won’t happen until it’s fully convertible.”