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China's reality is both boom and gloom
China's outlook is paradoxically both grave and rife with opportunity. A week before Chinas leader visited the U.S., Jon Markman went to Beijing and found both promise and pessimism.
By Jon D. Markman
A flight into Beijing these days begins the descent into a kind of hell.
Its not just the smog, which is pervasive, gray and suffocating on an epic scale. Its not just the weather, which is unseasonably cold and windy. Its not just the sand, which is blowing in from inner Mongolia in thick, yellow sheets. Its not just the traffic, which is inert due to the stunning lack of major cross-town freeways. And its not just the vibe of the citys residents and laborers, which is often foul and hostile amid the pollution and crowding.
Its the sense of alienation and hopelessness that you get from so many of the kind and brilliant people who have grown up there, and who should have the greatest stake in its success.
Its one thing, after all, to live and work in a city that is suffering short-term growing pains toward a sunny future. Its quite another to work in a town thats in the perverse process of being dragged backward into an industrial revolution that the West experienced a century ago, when expectations for living standards were so much lower.
I visited Beijing last week in advance of Chinese President Hu Jintaos arrival to my hometown of Seattle, and I discovered that for investors, the situation is paradoxically both grave and ripe with opportunity.
Theres little doubt that Chinas capital city is at the spearhead of the sort of double-digit, multiyear economic growth that you have read so much about, for construction cranes disappear high into the gray haze virtually everywhere you turn. Yet the pace of super-development seems almost too great, and may ultimately prove its undoing as the country is losing many of the smart, ambitious people that have fueled its dystopian miracle.
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Building a disjointed Middle Kingdom
Dan Zhou is a Shanghai-born, MIT-educated economist who is one of the leading analysts of the growing crisis in Beijing -- and he is not terribly optimistic.
We met in his office on the 10th floor of a downtown high-rise, where he studies Chinese business trends for overseas investors as head of the independent research firm CEB Monitor Group. The room swayed and moaned as winds sweeping down from the Gobi Desert buffeted the unsteady building.
Zhou first pointed out that despite skepticism from some western investors who think the theme is over-hyped, Chinas infrastructure build-out is still in the early innings. "Dont bet against the cycle," he said, arguing that all the road, building and power investments made so far have only helped the country begin to play catch-up after decades of under-investment.
The development of modern freeways, bridges, water supply and electrical plants for key hubs like Shanghai and Beijing alone is nowhere near complete. And yet those cities are home to less than a 10th of Chinas 1.3 billion population. If there is the political will to extend progress to the interior of the country, Zhou believes the recent success of concrete makers like Rinker Group (RIN, news, msgs), of Australia, and Cemex (CX, news, msgs), of Mexico, should go on for many years. Vast sections of downtown Beijing, for instance, today lie in rubble as officials bulldoze lively, old single-story neighborhoods, called "hutongs," in anticipation of new construction later on. They are being reborn into denser -- and far less socially connected -- apartment buildings by a government-sponsored work forces that work at a snails pace, with little of the basic safety equipment that Western laborers take for granted.
The erasure of hutongs is emblematic of a deeper theme Zhou believes investors must acknowledge: The division of China into two "disjointed" nations, divided by wealth. Just as it is hard to understand how the country can both have a Communist political system and capitalist economic system, it is hard to understand how it can be the rich financier of Americas budget deficit on the world stage and yet backward at home.
The uncomfortable fact, Zhou says, is that a thin sliver of urbanites has emerged -- typically through Communist Party connections -- as the super-rich, while much of the rest of the nation, including the hard-striving middle class, languishes in Second and Third World conditions. A housing tract that I visited in the suburbs, for instance, did not have indoor plumbing or regular garbage collection; fields were strewn with plastic waste. City center restaurants featured tremendous quantities of high-quality meats and vegetables, yet streets are rife with beggars and impoverished vendors. Thousands of newly planted trees lined freeways, yet most appeared dead, or nearly so, for lack of water.
A dangerous disconnect
The government needs to resolve this economic gulf somehow, as a nation in which a tiny minority enjoys the fruits of economic reforms could easily dissolve into chaos. Ironically, a similar disconnect between rich and poor in Europe and America resulted in socialist and communist movements, and governments fought back by implementing reforms.
In the meantime, many leading citizens are voting with their feet. More than three-quarters of the well-educated people that I spoke with expressed a desire to leave the country, in large part due to fears of the effects that pollution were having on their children. As an example, an expert in the design of power transmission told me he had found a job with a large electric grid construction firm in the Canadian city of Calgary, and was in the process of moving his family.
With 1.3 billion people to draw from, China will replace this engineer. But it cannot afford to lose so many of its best and brightest, who in my small sample expressed little of the sort of pride of country that you hear virtually everywhere else in the world. In private conversations, people express no great fondness for the feudal distant past, communist recent past, or hypercompetitive, money-focused present. Theyre not anti-government, necessarily, just cynical and apathetic amid a daily battle to survive and get ahead. Many expressed exasperation with the breakdown of a sense of community, noting that while families are still close-knit, few knew or cared much about their neighbors. In just a week, I witnessed several acts of open interpersonal hostility, including one screaming match in which a woman tore a branch off a tree to threaten another woman.
To be sure, I also witnessed and experienced incredible kindness and generosity -- and was delighted to walk through a major park on a Saturday to find hundreds of people engaged happily in a dizzying variety of sports and hobbies in small groups, from folk singing to cards, tai chi, and local versions of hacky sack, badminton and tennis.
Infrastructure, of one sort or another
If the communist government does decide to focus on reform to promote this sort of harmony, it may need to curb the construction of ports and railroads built for the convenience of its foreign business partners, and turn its spending instead toward domestic improvements less immediately favorable to foreign investors, such as improved green belts, hospitals, schools and water systems.
This is certainly the outcome most optimists would like to see, but there is also the potential for a much darker path. Zhou notes that although Asia is now peaceful -- relative to the Middle East, anyway -- there is a "vacuum" that could be filled by the sort of nationalism that emerged in Germany in the 1930s. Already there have been protests against Japanese companies. If pressed, the countrys clever propaganda machine could refocus its citizens anti-government anger toward South Asian, American and European interests.
Despite its tremendous size, after all, China is very resource-poor -- and if its leaders find themselves cornered, they may well feel the need to reach out and grab energy, food and water supplies through armed force. The Peoples Liberation Army is the worlds largest, although it is said to be relatively ill-equipped. That may be purposeful. In a sign that the government does not trust its soldiers, few of the security forces on the street carry weapons.
For now, though, theres no need for investors to get overly concerned about the potential for violence, as the stakes are high and domestic reorganization and improvement is much more likely. Your strategy to take advantage of Chinas pain and promise does not need to be complicated. Consider shares of major international cement, steel and construction companies, including such Europe-based heavy industrial firms as Metso (MX, news, msgs) of Finland, ABB (ABB, news, msgs) of Sweden and Siemens (SI, news, msgs) of Germany. Smaller companies to put on your list should include pollution-control systems maker Fuel-Tech N.V. (FTEK, news, msgs), water-pump maker Franklin Electric (FELE, news, msgs) and water systems provider Pentair (PNR, news, msgs). I will follow up on them over the next few years.
Fine Print
Beijing was blanketed Monday by grit from one of its worst sandstorms of recent years. Read about it here. Air pollution was so hazardous that officials warned citizens to wear masks outside to avoid respiratory problems. Air quality has met standards in less than half the days since the start of the year. ... Zhou's research on Chinese economic development is distributed in the United States and Europe by ISI Group. ... A month and a half ago, I recommended that investors who liked the "great man" style of investing embodied by Berkshire Hathaway (BRK.A, news, msgs) should consider the much-smaller and more-obscure Leucadia National (LUK, news, msgs) and Brookfield Asset Management (BAM, news, msgs) instead. Since then, Berkshire shares are down 3% while the latter are up 10% and 15%. ... Back in mid-February ("Snowbum stocks that really shred"), I suggested that investors enraptured by the winter Olympics considered skiing-related stocks K2 (KTO, news, msgs), Intrawest (IDR, news, msgs) and Vail Resorts (MTN, news, msgs). Theyre up 14%, 21% and 27% since.
Jon D. Markman is editor of the independent investment newsletters Strategic Advantage and Trader's Advantage. While he cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at jon.markman@gmail.com; put COMMENT in the subject line. At the time of publication, Jon Markman did not own or control shares of companies mentioned in this column.
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