Wages double in five years
The below graph reflects the rise in the average annual manufacturing wage in China. As discussed in the prior part of this series, this wage growth has picked up momentum after the 2008 financial crisis, and reflects some signs of acceleration post-2010. Plus, as pointed out earlier, it might be safe to expect China’s wage growth in manufacturing to grow at 10% or more per annum the next year or two—or even beyond. Presuming a 40-hour work week and 50 weeks per year, that would come to about an average manufacturing wage of $3.50 per hour—roughly half of the U.S. minimum wage of $7.25. However, the average hourly wage in manufacturing in the U.S. is $19.50 per hour—five and a half times that of China. This article considers the growing wage level in China and its effect on Baidu and other Asian equities.
Productivity growth is the key to wage growth in the long run
These wage differentials reflect significant productivity differentials between China and the U.S. manufacturing labor. Although with China’s manufacturing wages growing 10% per year more quickly than the U.S. manufacturing wages, it is easy to see that in perhaps ten years, the U.S. manufacturing base could be fairly close to the China-based manufacturing cost-to-productivity levels, even when a lot will depend upon the relative growth in China’s productivity growth versus the U.S. productivity growth over the next ten years. For Baidu, this trend would suggest that the domestic Chinese consumer will support the domestic economy in the future and that its earnings will grow in conjunction with growth in both Chinese wages and productivity growth. In the long run, this trend suggests that China will be able to grow its level of consumption and help the local less-developed Asian economies in the process. This is a good long-term outlook, although short-term risks of excess capacity and soft trade growth remain a focal point of concern for China.
Asia’s equity outlook
The weakening yen and a 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. An 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 could cool U.S. valuations going forward. Given China’s current financial challenges in the banking system, both the U.S. equity 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 can go.
For an overview of the U.S. macroeconomic recovery, which can support China’s export economy, read 2014 US macro outlook: The crack in the debt ceiling.
To see how the US and EU economic recoveries should support Chinese equities and Baidu as 2014 progresses, please see the next article.