We revisit two important investment themes:
China Slowdown
Yes, China is a compelling long-term growth story. So was the U.S. in the 19th century, but it still had financial panics and deep recessions in 1819, 1837, 1857, 1873, and 1893. Hopefully, China’s slowdown will not be that severe. But it will be difficult to seamlessly shift GDP growth from exports and investments to consumption, particularly because much of the investment that powered GDP was ill-advised “stimulus spending” on government-sponsored “white elephants” that did little to improve productivity and long-term growth. This is government spending only Paul Krugman could love. Before the slowdown is over, Wall Street economists will be arguing whether the GDP growth figure will have a 5-handle. Two new data points, both rather shocking:
1 According to The Wall Street Journal, “China issued a directive on Tuesday banning the construction of government buildings for the next five years, the latest in a series of initiatives . . . to discourage corruption and foster frugality at a time of broad popular resentment against high-living bureaucrats.” Roll that around in your brain for a while. A five year moratorium on government buildings? That’s pretty extraordinary, especially for a developing country. It is a stark admission that much of the recent spending was a waste. Keep in mind that construction of those buildings added to GDP in years past but won’t generate much income going forward.
2. The Journal also carried a story on a $91 billion industrial project – that’s a lot of money, folks, even in China – that was put on hold because it was so ill-conceived. Surveying empty buildings, steel worker Zhao Jianjun uttered an eloquent haiku to mal-investment: “You only need to look around to see how things are going. Look north, west, east.”
We regard China’s GDP figures as fictitious; even U.S. GDP is radically revised, sometimes turning strong growth for a given quarter into a slight decline, or visa versa. More meaningful than GDP is the HSBC PMI, which for July was 47.7, the third straight decline and weakest since August 2012. That’s pretty bad for an economy powered by manufacturing rather than services.
China Clean-up
China’s environment is a wreck, and as the middle class grows the political pressure to clean it up becomes ever more intense. This is a very broad-based theme involving everything from water conservation to air pollution, food safety, pharmaceutical purity, hospital cleanliness, etc. The issue was highlighted in another WSJ article titled “China Weighs Environmental Costs: Beijing Tries to Emphasize Cleaner Industry Over Unbridled Growth After Signs Mount of Damage Done.”
A clean-up is not just politically popular and environmentally necessary but also vital to China’s international competitiveness. Soccer moms in California, Germany, and Shanghai don’t want to serve fish from China laced with mercury, or give junior a toy adorned with lead paint. Chinese tourists load up on infant formula when they visit England or Germany because they don’t trust the domestic product; The New York Times refers to “Chinese parents’ obsession with foreign milk powder, which stems from distrust of domestic brands.” How weird is that?
The two themes are linked . . .
. . . because government spending will be diverted from unpopular and unproductive construction projects toward politically popular environmental clean-up.
A Premier Clean-up Play
One big beneficiary of these trends is Thermo Fisher Scientific, the leading producer of scientific instruments for laboratories and factories. Its slogan is “Healthier, Cleaner, Safer.” Last year Asia Pacific was 17% of revenue, with much of that in China. TMO makes equipment to identify pollutants such as mercury, lead, arsenic, etc. You can’t reduce what you can’t measure, so China will be spending a lot of money on such equipment in coming years. TMO was one of ten attractive stocks recently highlighted by hedge fund impresario Lee Cooperman at the Seeking Alpha Conference. Full disclosure: I have a long-standing long position in TMO; the stock has appreciated 42.5% so far this year and is not particularly cheap. Invest at your own risk.
The Q2 2013 TMO earnings conference call contained interesting commentary on the company’s business in China. Here is an abbreviated version of comments by CEO Marc Casper (emphasis added):
“In China, we’re using our scale to our advantage. We have manufacturing. We have an R&D center. We have multiple training centers. We have a business headquartered there. We’re closing in quickly on 3,000 colleagues. We recruit from the best universities.
“We are clearly very well-positioned in the market, and that’s helping us drive significant growth, having quite a number of quarters of 20%-plus growth and this being one of our stronger quarters that we’ve had. . . we’re very well aligned with the societal needs and the 5-year plan, which is around environmental protection, food safety and expanding health care capabilities, particularly in the west.
“And while I mentioned in my prepared remarks, to get multiple hours with an entire government for 100 million people in a province to really talk about our capabilities and their challenges and what the opportunities are for alignment, gives you a sense of the importance, even though they brought up in the dialogue that, yes, the industrial economy in their own province is a little bit weaker, and that has an effect on their GDP growth, but nonetheless, they thought it’s important enough to actually talk through what we could do and collaborate together to really meet their needs on their own priorities as well.”
Bottom line
We expect China growth to surprise to the downside over the next year; many investors are complacently expecting an easy transition to consumption led growth, despite multiple warning signs. But look for strong spending on environment clean-up, which will benefit TMO and also quite a few industrial companies involved in helping China build a cleaner infrastructure.
Copyright Thomas Doerflinger 2013. All Rights Reserved.
