Must-know: Will China’s consumer recovery support Baidu in 2014?

Part 2
Must-know: Will China’s consumer recovery support Baidu in 2014? (Part 2 of 10)

How the Chinese recovery helps hedge funds’ BIDU holdings

Bucking the trend?

The below graph reflects the long-term decline, but recent recovery in consumer confidence in China. Since 2008, China’s consumer confidence seems to have experienced a much larger decline than that of the U.S., suggesting that the “soft landing” scenario in China might still be a work in progress. However, gradual recovery in global growth is just starting to support a modest recovery in consumer confidence in China. Should this modest recovery continue to gain momentum as global growth data sees further upward revisions, perhaps much of the worst is over for the Chinese economic hard landing scenario. This article considers the prospects for China’s Baidu (BIDU) versus Google (GOOGL) in the U.S. and Yandex (YNDX) in Russia.

China Consumer Confidence 1997Enlarge Graph

For a more detailed comparative analysis on Google (GOOGL) versus Yandex (YNDX) and Baidu (BIDU), read Evaluating Yandex versus other key search engines.

Global consumerism weak, but recovering

This series explores the implications of China’s transition to a more consumer-oriented economy in the face of decelerating export growth and soft global economic growth. If China wants to hit its targeted growth rates of 7.5% plus per annum, it will need to grow its domestic economy, as heavy reliance on the U.S. and European consumer will likely be more challenging in the future than it was prior to 2008. In the U.S., there has been an ongoing trend in consumerism since the Reagan era of the 1980’s, with consumption as a percent of GDP growing from nearly 60% to 70% of U.S. GDP. Despite economic shocks, to include the 2008 crisis, the American consumer seems to continue to get back on his or her feet and consume at very high levels even when the rate of outright growth in consumption has slowed.

 China’s prognosis

While China’s historically high savings rates have been great for developing investment capital, the deceleration in export and economic growth is becoming a potential issue. With the U.S. and European governments running large (though shrinking) deficits to sustain consumption, China may not wish to look to the strong economies of the West to grow its economy through robust export growth rates and greater levels of consumption as a percentage of their economies. Even if China can continue to do so, as pointed out in a prior article, economists are becoming concerned that China’s $3.3 trillion foreign exchange reserves bubble is starting to distort the global economy in the form of a trade surplus bubble plowed into (mainly) the fixed income markets of the U.S. and Europe.

That is great for low rates on mortgages in the U.S. and Europe, but with fairly weak labor markets in the U.S. and Europe, perhaps rates have been low for long enough. The cheap financing may have gone too far for too long, and perhaps now the post-Reagan era consumption binge has finally led to apparent underinvestment in the U.S. and Europe, and has eroded the long-term growth rates of the economies. For China, that means more consumption and slowing investment—which seems to be just beginning. For Baidu, this would suggest a stronger domestic economy with increased purchasing power in China.

To know how the rapid growth in China’s wages should continue to support Baidu over Google and Yandex, read Wage inflation improves China’s consumption and Baidu’s sales.

Asia’s equity outlook

The weakening yen and relatively flat wage growth in Japan has supported Japanese markets, as reflected in Wisdom Tree Japan Hedged (DXJ) and the iShares MSCI Japan (EWJ) ETF’s. Aggressive monetary policy in the U.S. has supported the S&P 500 as reflected in the State Street Global Advisors S&P 500 SDPR (SPY), State Street Global Advisors Dow Jones SPDR (DIA), and Blackrock iShares S&P 500 Index (IVV), which have been up nearly 18% over the past year. However, tapering is now in play, and higher rates in the five-year treasury can cool U.S. valuations going forward. Given China’s current financial challenges in the banking system, both the U.S. equity markets and the Abenomics-driven Japanese equity markets may continue to outpace China’s iShares FTSE China 25 Index Fund (FXI) and Korea’s iShares MSCI South Korea Capped Index Fund (EWY). However, if U.S. valuations continue to increase over the year, China’s valuations should eventually become increasingly compelling. With FXI’s key holding, banking flagship Bank of China, trading at 0.84 price to book and a 4.95 price-to-earnings ratio, one has to wonder how much lower Chinese banks and financials could go.

To see how China’s consumption as a percent of gross domestic product is recovering, read the next article.

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