A worker picks cotton during the harvest season in Hami, northwest China's Xinjiang region. China is the largest cotton producer in the world, with cotton occupying a crucial position in the national economy and the basic means of livelihood for many Chinese.STR/AFP / Getty Images
James Chong is just back from China and full of enthusiasm for its prospects. Corporate profits are forecast to be strong, the country and its citizens have plenty of money and the government is on the verge of turning inward, shifting its focus from exports to the potentially huge domestic economy.
The government's thinking runs like this: With companies around the world seeking opportunities in China, "it should be a huge opportunity for us as well," Mr. Chong said in an interview. Mr. Chong, who visited 42 companies during his two-week visit, is portfolio manager of the BMO Greater China Class fund.
After a good year in 2010, corporate profits are forecast to leap an additional 15 per cent to 30 per cent next year, he said. "That's their conservative forecast." So far, Chinese companies say they have not been affected by the global slowdown.
As well, many industrial companies are determined to make at home the equipment they have been importing from Germany, Britain and other European countries, he says. Trojan heavy machinery, for example, says it can produce the same equipment - only less expensive and slightly better quality - than what it used to import from Germany. "It is even exporting back to Germany."
Other examples of import substitution abound.
Another strong driver of the economy is its remarkable liquidity, Mr. Chong says. The country is awash in cash. Indeed, China's huge foreign reserves - mainly U.S. Treasury securities - are putting upward pressure on the currency.
Corporations, too, are flush with money, so they have little need for financing. In the banking system, the loan-to-deposit ratio is a very low 60 per cent to 70 per cent, "which means banks are sitting on quite a lot of cash they can't lend out."
But the real clincher is the household sector. Chinese citizens' household savings add up to $4.5-trillion (U.S.), more than the gross domestic product of Russia, India and Brazil combined, Mr. Chong says.
Domestic consumption in China is about 35 per cent of GDP, compared to about 70 per cent in the United States, so it has plenty of room to grow.
Understandably, the government is scrambling to keep a lid on inflation, especially in the domestic property market. It already has controls on foreign institutional investment in its stock markets. Foreigners, such as mutual funds, who want to buy Chinese equities have to apply to the government for quotas.
The big risk to the stock market now is government policy, he says. The government recently raised interest rates by a quarter of a percentage point to cool the real estate market, surprising the financial markets.
Because all the money floating around could easily push up property prices, "they're taking pre-emptive action to deflate a possible bubble," which, as Americans know all too well, could seriously damage the larger economy.
So where is Mr. Chong finding value?
"We are overweight the technology sector," he says. "The valuation is quite reasonable because people are not paying attention to it."
China's huge foreign exchange reserves and its export success have led to repeated calls for the country to let its currency rise more quickly.
"They understand that," Mr. Chong says. But rather than suffer the dislocations of a rapidly rising currency, China is determined to do it gradually.
"Not many people realize that in the past three years, the currency has risen by 18 per cent," he says. The incremental increase allows Chinese companies to take the rise in currency value into account when they are doing their pricing, he adds.
China learned from Japan's mistake, Mr. Chong says. The rapid runup in the yen in the mid-1980s and the bursting of the property bubble plunged the country into a 20-year slump from which it has yet to recover.
Mackenzie is among the Canadian fund companies captivated by China's promise.
"China is a market where we see significant opportunities on a number of fronts," Tim Morris, client portfolio manager for the Mackenzie Universal Emerging Markets Class fund, said in an interview.
"It boils down to very large domestic, growth-oriented, retail and consumption-oriented opportunities," he says, fuelled by continuing waves of urbanization as people move from the country to some of the larger, coastal cities in businesses ranging from supermarkets to sporting goods to luxury goods.
Bond fund managers, too, are finding value in China. Tom Nakamura, co-manager with Tristan Sones of the AGF Global High Yield Bond Fund, counts Noble Group corporate bonds yielding 5.6 per cent among his Asian holdings. Noble is in the business of shipping logistics, an area that benefits from commodity movements without being exposed to volatile commodity prices.
"It's one of our favourite long-term corporate credit stories and we think it's poised to continue to do well," Mr. Nakamura said in an interview.
Meanwhile, investment banker UBS AG predicted recently that Chinese stocks are about to enter a bull rally after having underperformed for most of the year as the government drafts details of its next five-year economic plan. The firm raised its recommendation on China's real estate industry to "overweight" from "neutral" and affirmed its overweight recommendation on the consumer, Internet, machinery, cement and construction and oil and gas industries.