We wrote last week that we must be careful of thinking China or emerging markets in general can cover for the lack of growth in the West. I’ve spoken to several people since who have told me that I just don’t understand how well China manages its economy. For the last decade or so China has demonstrated some pretty impressive management, they say. The country’s leaders have smoothed out the economic cycle and kept growth knocking around 10% or so. That they have done so suggests they’ll be able to keep doing so.
I’m fine with the first bit of that, but not with the second. As Angus Tulloch of First State points out, most of us have a great tendency to be “prisoners of recent history” (we think that whatever happened yesterday is the thing most likely to happen today). But we really need to take a longer-term perspective on things. All fast-industrialising countries have seen varying degrees of growth during their heydays (the UK had a nasty recession in the 1830s, for example), so why should China be immune?
China might have had a good run, but let’s not forget that it beat the cycle in 2008 only by chucking a massive credit stimulus into the mix. It did the job at the time, but the unwelcome side effects – in particular the huge misallocation of capital to the property sector and a sharp rise in inflation – have now come to the fore. “Reversing these excesses,” says Tulloch, “without giving rise to further nasty repercussions is proving to be difficult.” That’s particularly the case in an environment in which Europe and America are at the beginning of picking up the pieces of their own credit binge. Whatever you might hear about decoupling, the fact is that the West is still China’s biggest customer. China might have abolished boom and bust for one decade, but that doesn’t mean they can do it for another.
Those caught up in extrapolating recent history out further than they ought might want to note a few more things. First, that having outperformed for a decade, emerging markets’ stocks are no longer outperforming: they are now available, says the FT, at a “slight discount” to developed market stocks. Second, it is I think useful at a time when everyone is looking for the bottom to some market or other to note why it is that we are bothering to do so. It is because most of those of us working in the market at the moment think of the years from 1980-1999, the 20-year period in which equities regularly returned 8%-10% a year, as normal. We expect to see these returns again as soon as our current difficulties have worked themselves through.
But 8%-10% isn’t normal. Look at things with a longer-term perspective and you’ll see that it is rather rare. As PFP’s Tim Price points out, since 1700 the period 1980-1999 has been the only one that has seen returns of this level. The rest of the time 20-year real returns have mostly knocked around zero.