The China Question By Lewis J. Walker, CFP(R)

Coming off of the 2008-2009 recessionary stock market lows, myriad factors drove the market advance, including the growth of China. In many ways, the bull was in the China shop. In 2014, China accounted for roughly 40% of global growth. With growing volatility in daily market trading, worries about a Chinese slowdown are impactful. What happened?

As a traveler this writer was first exposed to Asia and Hong Kong as a window into China in 1964, with return trips to Hong Kong over the years. My first trip into “mainland China” was in 2000 and subsequent trips took me to Beijing, Shanghai, Guangzhou, Chongqing, Suzhou, and elsewhere. China is a study in transformation, and results are startling.

Following the death of Chairman Mao Zedong in 1976, Deng Xiaoping, from 1978 to 1992, steered the country away from the wreckage of the Cultural Revolution. Declaring, “Poverty is not socialism. To be rich is glorious,” he led the country through globally-significant market reforms. His concepts of socialist ideology mixed with pragmatic market practices continue today under Xi Jinping.

China is not a free-market capitalist democracy. For good or ill, there’s the rub. There is one party—the Communist Party—and the game aims to preserve the power and influence of the party. In China, most land is owned by collectives or the state. If the government wants something built, it happens; no zoning or environmental delays; people are uprooted. In 2014 Bill Gates observed that “China used more cement in the last three years than the U.S. used in the entire 20th century.”

China is a command economy with massive government financing, inefficient state-owned enterprises (SOEs), and regulations designed to control people and markets. Are we surprised that capital was misallocated and growth slowed, even as China’s economic performance continues as a driver of supply and demand around the globe?

Many emerging economies reliant on exports of natural resources and other commodities are struggling. As the American and European economies slowed in the wake of the 2008 credit debacle, the U.S. introduced quantitative easing as a stimulus and the lowest interest rates in decades. Thinking the China boom would go on ad infinitum, many producers (e.g., sugar producers in Brazil) borrowed money for local investment in expanded facilities to meet Chinese demand, with loans repayable in dollars. With the U.S. dollar appreciating against other currencies, the debtor squeeze is on. With prices of many commodities down by half or more, paying back loans in increasingly expensive dollars is precipitating bankruptcies, mergers, and bargains for the astute. Threats to the high yield bond market are one reason Janet Yellen did not raise interest rates in September.

China is navigating a transformation from an export-fuelled economy to one led by domestic demand and consumption. The Chinese people are big savers. Now Mr. Xi is pushing domestic spending. It may be a virtue to get rich, but hey, folks, get out there and spend some money! Such reforms will take time. If Xi errs, markets will react.

There are positives in the China story. Low commodity prices transfer income from producers to consumers. In America, where personal consumption is 65%-70% of GDP, reduced commodity prices have the simulative properties of a tax cut, despite the hit to producers in areas like the shale oil patch. Writing in London’s Financial Times, Diana Choyleva, chief economist at Lombard Street Research, sees a “‘deflationary boom’ outlook for the world. Our analysis suggests both deflation and boom still have further to run, with investors likely to keep lurching between the positive and negative aspects of this pattern of growth.”

Ms. Choyleva’s advice? Acknowledging the possibility of stumbles in China’s reforms, nevertheless she postulates that the positives in Chinese policy changes “make U.S. stocks a buy on dips.”

China has challenges. Not far from the glitz of Shanghai is “third world China,” with dirty air and pollution problems. Yet China possesses huge financial reserves with resourceful hardworking people. Mr. Xi has launched an anti-corruption campaign. He is trying to clean up the environment and past excesses, embracing further market reforms. Having a glimpse into the progress made by China over the years, it would be a mistake in my view to count them out.

Anxieties over China in the short-run should not impact your long-run equity investment strategies. Find a money manager with a track record of spotting winners and losers based on solid fundamental analysis.

Lewis Walker is President of Walker Capital Management, LLC. Securities and advisory services offered through The Strategic Financial Alliance, Inc. (SFA). Lewis Walker is a registered representative and investment adviser representative of SFA which is otherwise unaffiliated with Walker Capital Management, LLC.