Fraud, corruption, impenetrable ownership structures, credit bubble, underdeveloped financial markets, command economy, ageing population, dodgy accounting. These are just some of the reasons for not investing in China.
But after recently visiting Beijing and Shanghai my first thought was how much development there was to go. While Pudong – the central business district in Shanghai – is modern and eye-catching like the world's other major financial districts, you don't have to walk far on the other side of the river to see derelict residential buildings that would never pass inspection in Australia.
The process of developing modern buildings to increase people's living standards still has decades to run despite the country's remarkable progress over the past 20 years. The Chinese people have a lot to look forward to.
There are major issues, however. The pollution is not only a health risk but after several days it starts to affect your overall mood. I always look forward to returning to Australia after travelling abroad, but I've never considered that blue skies would be something I'd miss again after suffering through two winters in London 15 years ago. We take our environment for granted in Australia, but many Chinese who have grown wealthy from the property boom are leaving the country at least partly because of environmental concerns.
A lady we met who worked in advertising was given €500,000 by her parents to get a Portuguese visa, after the value of their home increased tenfold over the past decade. While record numbers of Chinese are graduating from university, a lot of brains and wealth are being exported overseas.
The housing bubble is also impossible to ignore. On our five-hour journey between Beijing and Shanghai on the high speed rail travelling at 320km/h we saw thousands of empty apartment buildings at various stages of development that are unlikely to ever be lived in. They were mostly in regional areas and too expensive for the local population.
Unfortunately generations of family wealth has been poured into overpriced property either directly or through wealth management products that invest in property development because there are few alternatives. Deposit rates are kept artificially low, the bond market is underdeveloped, investors are wary of the sharemarket given its lousy performance and locals are barred from investing overseas. I have 800 yuan (about $140) at home in my drawer because it cannot be exchanged. Wealthy people often gamble in Macau because they can exchange yuan into foreign currencies.
The productivity benefits of China's massive infrastructure spending are also declining rapidly. China has roads that Sydneysiders can only dream of and the extensive rail network always runs on time. The high-speed Shanghai Maglev delivers passengers to the airport in just eight minutes at 430 km/h.
With so many useful projects now complete, new infrastructure is lying unused (airports without planes, stadiums without fans and malls without shoppers or retailers) and more wasteful stimulus programs are only likely to produce more bad debts. China's private debt levels are reportedly higher than Australia's, which lead the western world. As far as fixed asset investment is concerned, the low hanging fruit has already been picked.
Exposed to market forces
In stark contrast to when I visited Russia 15 years ago, I never felt like I was in a communist state except in Tiananmen Square in Beijing. But there's a raft of financial, political and social changes that China will make over time. The economy currently doesn't have many shock absorbers, such as a readily convertible currency market and a liquid bond market.
There's not much of a social safety net, either. The pension is apparently $50 per week, which is why families save so hard and there's so much pressure on children to get a good job. There are also many jobs that will eventually be replaced by machines, such as street cleaners that earn US$5,000 per year. As growth slows and property prices fall, all eyes will be on how the population reacts. They have never been so exposed to market forces.
It might not happen in my lifetime, but I expect China will eventually become a democracy. As China's development continues and more citizens are exposed to western ideas, it's inevitable that the population will seek greater input into their future. Much to my surprise, the local newspapers were filled with critical analysis of social, financial and political issues.
China is a place of opportunity. But the lack of western brands and advertising shows that it's not an easy market to crack. Aside from the familiar luxury and alcohol brands, Starbucks, McDonald's and KFC were the most common western franchises we saw. You should be sceptical of any company that's betting on China to transform its business.
Over the past three years we've been favouring businesses offering overseas exposure to profit from slowing growth in China and a lower Aussie dollar. But with stock prices for companies like CSL and Macquarie Group more than doubling there's little margin of safety in their valuations.
Ironically, for intrepid investors the best way to profit from China's slowing growth may be to invest in Chinese companies. Platinum Asset Management's March quarterly report shows that the Chinese stock market is priced lower than what Asian indexes were at the trough of the Asian Crisis nearly 20 years ago.
Investing in China is not for the faint hearted and we expect that there's plenty of pain to come as the economy slows. While there's no room for complacency, like Russian stocks, Chinese stocks are currently priced for disaster and there are plenty of fast growing stocks that will flourish for years to come.