Long-term growth may be a given in China, but the rate of change of that growth and the mix of where it is to be found will dictate how to make money in the markets, says Howard Wong, director of Hong Kong-based hedge fund Doric Capital.
Doric’s two hedge funds manage a total of around $120 million at present. These assets fell to around $27 million after Michael Nock retired in February last year. Nock is now primarily based in Australia, where he paints (pictures, not the garden fence) and remains a director of Doric Capital and a major investor.
What Wong means by the ‘mix’ in China is where the drivers of growth will come from. The powerhouses of growth today may not be the same in the future.
He gives the example of the Chinese steel industry, which produced 80 million tonnes of steel in 2000 and now produces 700 million tonnes a year. (Compare that to the US where steel production peaked at 120 million tonnes a year in the 1970s, before the industry got into trouble and steel mills shut down. Today, the US steel industry produces about 95 million tonnes per year.)
So China has a lot of steel to use. Where can it all go? Just look at the plethora of airports in the Pearl River area, where every city has its own runway. Those airports are now filling with traffic, but you don’t need a new airport every year, so that steel has to go somewhere else – towards new railway tracks, for example.
The Chinese steel industry helps drive other industries, such as the coal industry. So a lot of jobs in China are riding on everything being properly managed. The investment in infrastructure uses up a lot of steel, but what happens if the loans made by banks to local government to pay for it all don’t get paid back?
What happens if the central government tries to twiddle with land prices to prevent a real-estate bubble and ends up driving them heavily down, thereby hitting local governments’ land sale receipts (an important source of income if they are to repay loans)?
It’s all a very delicate balance.
“The heavy cyclicals have already factored in a reduction in the rate of change of growth and a consolidation,” says Wong. “Industries like the Chinese steel sector are not in the growth end game yet though, so there is still money to be made by trading. Take Angang Steel, one of China’s biggest producers, whose stock price fell from $18 to $8 and now is around $11-12 .”
However, as China moves more towards consumer-based growth, there will be winners and losers in market sectors. For instance, Wong thinks a long/short fund is a better choice than an ETF, because the big winners may be pulled down by the underperformers in the index as their particular industry’s day in the limelight fades.
“The banks and cyclicals that compose a big proportion of the index may not be the main beneficiaries of adjustment,” he says.
Doric’s own stock-picking has worked well this year, with its small-cap fund up 20%.
Wong also takes the view that – rather than just producing more and more of a certain item (like bog-standard steel) – China will shift towards making better quality products, and, to that end, will invest in branding and research and development.
For those who think China can only do the simple stuff and not the visionary innovations, domestic researchers are mooting a vacuum tube train driven by magnetism. The vacuum would allow the train to travel so fast that it could get from Beijing to New York in about an hour.
To build it would require a really big tube – which, again, would presumably need a lot of steel.