2016 took off to a less than stellar start with global markets closing sharply lower in the first week of the New Year. The Chinese stock market’s circuit breaker was triggered twice in a short span of two weeks. The Chinese Renminbi nosedived in the first week. $100 billion was wiped from the ASX in 11 days. Oil prices continued to slide having plummeted 75% since mid 2014. The Dow and S&P 500 also had their worst five-day starts in history.
With this chaos plaguing the stock market, it is understandable that many investors are becoming increasingly anxious about their portfolios – especially those with exposure to the Asian markets.
Let’s talk about China
While the APN Asian REIT Fund has no exposure to the Chinese Stock Markets, the volatility and headlines has made it an important topic to address, so let’s talk about China. China has shaken investor confidence with surprise currency moves and haphazard market regulation. Here is a brief introduction to the Chinese stock markets.
It is important to note that the Chinese stock market is still in its early stage of development and going through some teething pains. A lack of reliable information and transparency has resulted in notorious volatility (past and ongoing) as well as issues around accurate valuation of stocks.
There is generally a disconnect between Chinese equity markets and its economy; shares have tended to rise and fall on sentiment and government policy moves, rather than economic fundamentals or earnings expectations.
The Chinese share market index is also dominated by state owned enterprises – this has resulted in the Government using the stock markets as a policy lever. In a developed nation like the United States, around 50% of the population own stocks and corporations rely heavily on funds raised on the stock market – this can inflict pain on the economy.
However, this is different in China’s case – according to the Boston Consulting Group (BCG), there are about 200 million retail investors in China, which represents less than 15% of the population base of 1.375 billion. The Chinese investors’ equity holdings are dwarfed by their investments in property, wealth management products and bank deposits. Equity-raising also makes up less than 5% of corporate fundraising, with bank loans and retained earnings the biggest sources of funds instead.
As a comparison, the equity market capitalisation percentage to GDP is 35% in China, vs nearly 100% in the US. Therefore, while China’s economy is growing at a slower rate now, it is not in the state of turmoil that the financial markets would suggest, and the converse is true – that stock market turmoil has limited direct impact on China’s actual economy.
What matters – The economy
So, what does matter to us about China? The economy.
China is the world’s second largest economy. Economic growth in China has been strong for the last several decades, driven by a focus on investments and exports. It is now beginning to slow. As with many developing economies, a transition to consumption-led growth is now deemed essential for sustainable economic expansion. China is undergoing this shift, from an export-driven and investment-led one to a more balanced, consumption-oriented economy.
Growth in this Asian powerhouse has fallen in recent years, with real gross domestic product expanding at less than half the pace of 2007. The official growth rate has slowed from 7.3% in 2014 to 6.9% last year – Beijing’s official target is “around 7%”.
More importantly, while the global investment community tends to focus on the headline growth number, it is easy to forget that because China’s economy is so much bigger after its tremendous growth spurt, in terms of absolute growth it is still contributing more to the global economy than it did a decade ago.
To give a more concrete example, when China’s output grew “only” at 7.3% in 2014, its slowest rate of growth in almost a quarter century, the absolute increase in nominal output was as big as an entire top 20 economy like Turkey.
In a similar vein, because of the larger base, by achieving growth of 6.9% in 2015, China added 50% more purchasing power than it did in 2010 when GDP growth was at 10.6%. Another important marker of a robust economy is employment – employment rates continue to grow, unemployment rates remain low and steady, despite the slowdown in GDP growth from 12.0% to 6.9% over the last 5 years.
The services’ share of China’s GDP has risen steadily over the past few decades. According to IHS Global Insight forecasts, in 2015, services share of China’s GDP, a broad measure of total economic activity, rose 2.4 percentage points to 50.5 percent — the single largest annual gain since 1985, and also 10 percentage points more than the once-dominant manufacturing sector.
Even more relevant, the growth rate of the services sector grew 8.3% over 2015 vs the manufacturing sector at just 6%. Like Australia during the mining boom, China now has a two speed economy. The full year numbers showed that power consumption grew by just 0.2% in 2015, while property investment was an anaemic 1%. But on the other side of the ledger retail sales were up 11.1% for the full year and average per capita urban disposable incomes rose 8.2% in 2015.
While the pace of overall economic growth is slower and the course likely bumpier, consumption growth in China is still tracing a staggering trajectory. According to a BCG report, China’s consumer economy is projected to expand by about half, to $6.5 trillion, by 2020, even if annual real GDP growth cools to 5.5% which is below the official target.
This incremental growth of $2.3 trillion alone over the next 5 years is comparable to adding a consumer market 1.3x larger than that of today’s Germany or UK.
The Chinese consumer
BCG projects Chinese consumption to grow 9% annually through to 2020. Since 2010, per capita income in China has been increasing at 11% per annum – this is likely sustainable given average wages should continue to rise as the economy shifts from low-wage manufacturing to better-paying service and high-tech industries.
What is more relevant about this growth in consumption overall is the rise of the upper-middle class. BCG projects that by 2020, the number of upper-middle class and affluent households will double to 100 million and account for 30% of all urban households, compared with 17% today (7% in 2010). These households are expected to grow spending by 17% per year and will account for 55% of Chinese urban consumption and 81% of its incremental growth through to 2020. These households are more likely to be concentrated in huge metropolises such as Beijing, Shanghai and Guangzhou as well as tier 2 and 3 cities.
Driven by the growth of the upper-middle class, BCG projects spending on services in China to increase 11% annually through 2020 – the key reason being that wealthier consumers spend a larger share of their incomes on services than do lower income consumers. The rise of the young generation of Chinese consumers will also transform the marketplace.
Take Starbucks for example – Starbucks is making a huge bet on China having converted a nation of tea drinkers into coffee lovers. On the back of expectations that per capita coffee consumption in China will grow 18% annually between 2014 and 2019, Starbucks plans to open over 2500 stores over the next 5 years – more than one a day – and expects China to overtake the US as its largest market.
It is clear that the growth of the Chinese consumer has far reaching implications for economies in the Asia Pacific region, for example Singapore and Australia are taking advantage of the rising demand for high quality education in China by expanding exports of college services, Japan is benefiting from Chinese tourists’ aggressive spending habits so much so that the phenomenon (known as bakugai) was termed the buzzword of the year in Japan, and expanding Chinese wealth management firms are setting up offices in Hong Kong.
How is the APN Asian REIT Fund positioned?
Cutting through the noise of stock markets and remaining focused on fundamentals, we continue to believe that there remains an abundance of growth opportunities in Asia as a whole and especially in the case of Asian commercial real estate. In line with APN’s long held “property for income” philosophy that we have embraced since 1998, the Asian REIT Fund aims to deliver value by investing in high quality commercial real estate backed by stable and consistent rental cash flows.
The Fund does not invest in any stocks listed on the Chinese Stock Exchanges; the three key markets that we do invest in are mature Asian markets – Singapore, Japan and Hong Kong – which are as robust as other developed markets around the world.
As you can see from the charts below, throughout the recent periods of extreme volatility in the Chinese market, the Fund has consistently stood resilient due to our strict adherence in investing only in high quality Asian commercial real estate that not only provide us access to the Asian growth story but equally important, the backing of strong cashflows which provides a level of protection from market and economic fluctuations; short term market volatility does not affect the ability of the REITs to sustain their distributions.
APN Asian REIT Fund – Defensive nature exhibited through volatile periods
The companies that we do invest in that have some exposure to assets in China (approximately 10% of our portfolio) are listed in highly regulated markets of Singapore and Hong Kong. These assets are predominantly retail malls that are beneficiaries of China’s shift from export driven growth to a consumption driven one, as described earlier in this paper.
Despite the slowdown of the Chinese economy as a whole, the retail sector (especially mass market consumption which is our main focus) remains strong and is actually picking up with more Chinese moving up to the middle class – the sweet spot for consumption growth. More specifically these assets are located in Tier 1 cities, being Shanghai, Beijing and Guangzhou – these REITs are sponsored and managed by best in class asset management teams in the region such as Singapore based Capitaland.
The volatility in the Chinese stock market is a result of panic and overreaction by jittery investors globally, but we believe it is by no means an accurate depiction of economic fundamentals on the ground. China’s growth remains one of the strongest in the world with multinationals such as Starbucks continuing to make substantial investments there.
China is moving up the value chain and the ‘new normal’ according to President Xi, is one of slower but better quality (more sustainable) growth over the long term – a normal trend as a country enters the next phase of its maturation cycle. A more sustainable China growth story will continue to make a positive impact on the growth of the developed Asian economies (Singapore, Japan and Hong Kong), and the APN Asian REIT Fund is well positioned to capitalise on the flow on benefits to commercial real estate throughout Asia.