From the outset of Kerr Neilson's overview of his recent trip to China, Neilson makes it clear that he hasn't "lost interest in China's re-emergence." Quite the opposite really, as Neilson goes on to state "What has been achieved has to be seen to be believed."
Where Neilson, who is the founder and major shareholder of Platinum Asset Management (ASX: PTM) does diverge from the "everything is ok" brigade are his observations that "the system is under huge stress."
There are a plethora of insights to be drawn from Neilson's trip to the cities of Shenzhen, Nanjing, Yichang, Chengdu and Shenyang but a few which stood out particularly were:
- Labour costs are up in coastal cities (15% in one year in some regions) which have reduced the competitiveness of China with other low cost countries. Moving inland or value-adding is countering this to some degree.
- Some anecdotal evidence suggests wage rates in countries including Egypt are now one-tenth the rate of China.
- State Owned Enterprises on average earn an estimated 3% to 4% return on capital employed and have more capacity than they need.
- Credit expansion is the real problem.
- In China lending appears focussed on the ratio of debt to assets, not debt to equity (scared yet?!)
- Lending appears to be focussed around property values (and their presumed continued increase) not around cash flows.
All the issues Neilson highlights lead him to suggest that China's economy is facing a very bumpy ride. On the never-ending discussion of China's growth rate he notes that the "official growth real rate of 7.5% seems unduly optimistic given our reading of the stress that will come from the inevitable failure of firms and ongoing consolidation."
Neilson isn't a lone voice either. In keeping with the theme that the China story is evolving, Dr Shane Oliver, the Head of Investment Strategy and Chief Economist at fund manager AMP (ASX: AMP) in his recent "Oliver's Insight" newsletter suggested that developed markets such as US, Japan and Europe were starting to look a little brighter, while emerging markets such as China, India, Brazil and Russia were starting to lose some of their glow.
Foolish takeaway
A reading of the above should rightly leave investors concerned about the economic outlook for China. But as (nearly) always in investing there are opportunities, it's just a matter of seeking them out. As Neilson points out "there are several sectors that will grow regardless" – he highlights logistics and e-commerce as two. Iron ore didn't rate a mention!
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Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.
