We revisit two important investment themes:<\/p>\n
China Slowdown<\/b><\/p>\n
Yes, China is a compelling long-term growth story.\u00a0 So was the U.S. in the 19th<\/sup> century, but it still had financial panics and deep recessions in 1819, 1837, 1857, 1873, and \u00a01893.\u00a0 Hopefully, China\u2019s slowdown will not be that severe.\u00a0 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 \u201cstimulus spending\u201d on government-sponsored \u201cwhite elephants\u201d that did little to improve productivity and long-term growth. This is government spending only Paul Krugman could love.\u00a0 Before the slowdown is over, Wall Street economists will be arguing whether the GDP growth figure will have a 5-handle.\u00a0 Two new data points, both rather shocking:<\/p>\n 1\u00a0 <\/b>\u00a0According to The Wall Street Journal<\/b>, \u201cChina 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.\u201d\u00a0 Roll that around in your brain for a while.\u00a0 A five year moratorium on government buildings?\u00a0 That\u2019s pretty extraordinary, especially for a developing country.\u00a0 It is a\u00a0stark admission that much of the recent spending was a waste.\u00a0 Keep in mind that construction of those buildings added to GDP in years past but\u00a0won\u2019t generate much income going forward.<\/p>\n 2.<\/b>\u00a0 The Journal<\/b> also carried a story on a $91 billion industrial project \u2013 that\u2019s a lot of money, folks, even in China \u2013 that was put on hold because it was so ill-conceived.\u00a0 Surveying empty buildings, steel worker Zhao Jianjun uttered an eloquent haiku to mal-investment:\u00a0 \u201cYou only need to look around to see how things are going.\u00a0 Look north, west, east.\u201d<\/p>\n We regard China\u2019s 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. \u00a0More meaningful than GDP is the HSBC PMI, which for July was 47.7, the third straight decline and weakest since August 2012.\u00a0 That\u2019s pretty bad for an economy powered by manufacturing rather than services.<\/p>\n China Clean-up<\/b><\/p>\n China\u2019s environment is a wreck, and as the middle class grows the political pressure to clean it up becomes ever more intense.\u00a0 This is a very broad-based theme<\/b> involving everything from water conservation to air pollution, food safety, pharmaceutical purity, hospital cleanliness, etc.\u00a0 The issue was highlighted in another WSJ article titled \u201cChina Weighs Environmental Costs: Beijing Tries to Emphasize Cleaner Industry Over Unbridled Growth After Signs Mount of Damage Done.\u201d<\/p>\n A clean-up is not just politically popular and environmentally necessary but also vital to China\u2019s international competitiveness. Soccer moms in California, Germany, and Shanghai don\u2019t want to serve fish from China laced with mercury, or give junior a toy adorned with lead paint.\u00a0 Chinese tourists load up on infant formula when they visit England or Germany because they don\u2019t trust the domestic product; The New York Times<\/b> refers to \u201cChinese parents\u2019 obsession with foreign milk powder, which stems from distrust of domestic brands.\u201d\u00a0 How weird is that?<\/p>\n The two themes are linked . . . <\/b><\/p>\n . . . <\/b>because government spending will be diverted from unpopular and unproductive construction projects toward politically popular environmental clean-up.<\/p>\n A Premier Clean-up Play<\/b><\/p>\n One big beneficiary of these trends is Thermo Fisher Scientific, the leading producer of scientific instruments for laboratories and factories. Its slogan is \u201cHealthier, Cleaner, Safer.\u201d\u00a0 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.\u00a0 You can\u2019t reduce what you can\u2019t measure, so China will be spending a lot of money on such equipment in coming years.\u00a0 TMO was one of ten attractive stocks recently highlighted by hedge fund impresario Lee Cooperman at the Seeking Alpha Conference.\u00a0\u00a0 Full disclosure:<\/b> I have a long-standing long position in TMO; the stock has appreciated 42.5% so far this year and is not particularly cheap.\u00a0 Invest at your own risk.<\/p>\n The Q2 2013 TMO earnings conference call contained interesting commentary on the company\u2019s business in China.\u00a0 Here is an\u00a0abbreviated version of comments by CEO Marc Casper (emphasis added):<\/p>\n \u201cIn 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.<\/p>\n \u201cWe 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. . .\u00a0we’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.<\/b><\/p>\n \u201cAnd 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.\u201d<\/p>\n Bottom line<\/b><\/p>\n We expect China growth to surprise to the downside over the next year; many investors are\u00a0complacently expecting an easy transition to consumption led growth, despite multiple warning signs.\u00a0 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.<\/p>\n Copyright Thomas Doerflinger 2013.\u00a0 All Rights Reserved.<\/p>\n","protected":false},"excerpt":{"rendered":" We revisit two important investment themes: China Slowdown Yes, China is a compelling long-term growth story.\u00a0 So was the U.S. in the 19th century, but it still had financial panics and deep recessions in 1819, 1837, 1857, 1873, and \u00a01893.\u00a0 … Continue reading