Jump out of a taxi on to the world-famous Bund and you are greeted by a forest of skyscrapers across the water in Pudong. But you will also be greeted by beggars grasping for a spare renminbi, and, sadly, most are elderly. Then cross the eight-lane highway, dodging the Toyotas and Volkswagens, to be confronted by doormen beckoning you into £100-a-head restaurants. Welcome to Shanghai, the embodiment of the Chinese economic dream and the world capital of inequality.
I am awed by the pace of development of this miracle economy. But below the surface there is plenty to alarm investors. Will growing tensions in America and Europe over trade deficits, combined with the possibility of an American recession, burst the bubble? Will internal inflationary pressures kill the boom? Will the gravity-defying Shanghai stock exchange fall back to earth after the Olympics? Probably – but that still leaves investors plenty of time to take profits.
Let’s start with some dazzling economic facts about Shanghai. In just 15 years this city has knocked up 4,000 skyscrapers – that’s more than in the whole of New York. Twenty years ago my brother visited the city and said he saw seven cars, and they all belonged to the government. Today this metropolis of 21.5m people – it vies with Sao Paulo and Mexico City for the title of world’s biggest city – has more than two million cars on unclogged streets and elevated highways.
But the figures are about quantity, not quality, and it’s quality that is nearly completely missing in modern China. Most of Shanghai’s mid-height skyscrapers will not last a generation. The water and sewerage system is failing to cope, causing a lavatorial stink in Shanghai’s streets and alleys.
Even so, equity investors should not be alarmed, for what impresses about Shanghai is not so much the skyline but what is happening at street level. Shanghai is not an international city in the style of Hong Kong or Singapore. Step away from the small foreign enclave around Xintiandi and within moments you will be the only non-Chinese speaker around. What Shanghai shows us is the modern, domestic Chinese consumer. The shoppers are Chinese, the products they are buying are Chinese. Yes, there’s the city-centre Raffles City, a glossy mall dripping in Gucci and Louis Vuitton. But the retail hub of the city is Xujiahui, a cluster of department stores and shops without a foreigner in sight.
Needing warmer clothing on a chilly November morning, I bought a corduroy jacket for Rmb250 (about £17). Like virtually all the clothing in the store, it was of lowish quality, and only a week later a button fell off. But that’s not the point. The store was busy with mainstream Chinese consumers for whom a Rmb250 jacket is now commonplace.
At Hom-Mart, a B&Q-meets-Asda style retailer, fridge-freezers cost £100 or less and televisions as little as £15. Once again, the brands and quality would not attract Western shoppers, but they are being snapped up by domestic buyers.
What Shanghai is saying is that China is at a stage where exports to the West will become less important as the vast domestic consumer market cranks up demand.
At the Jinmao tower, one of the few that will stand the test of time, I meet Standard Life’s chief executive for Asia, Alan Armitage. He runs Heng An Standard Life, now operating in 14 Chinese cities. He estimates that by 2010 there will be 100 million Chinese individuals with investable assets of $100,000 (£48,000) or more, not including their property.
Heng An Standard Life already has a direct sales force of 2,500 and Armitage expects to have 40,000 sales agents by 2012. That is more than double the total number of IFAs in Britain. Ping An, the biggest domestic life and pensions company, has 500,000 sales agents.
Most Far East and China fund managers have been buying into the domestic China story for a while now, and it’s easy to see why. Standard Life Investments itself has a bit of an undiscovered gem in its own Asia Pacific Growth fund, run by Magdalene Miller. It focuses on a mix of China domestic plays plus some astute holdings in Australian resource stocks (BHP and Rio) supplying the Chinese. Over the past year it is up 56.9% compared with a sector average of 50.7%.
Standard Life Investments expects an American slowdown to put Asian stocks under pressure. But it says that Asian stocks have strong corporate fundamentals and, in some cases, attractive valuations, and it expects that growth will be sustained by domestic consumption, underpinned by high savings rates and employment levels.
The biggest worry for China investors should be inflation. When Chinese consumers can afford to splash out on clothing and electricals, it tells you that they are not being paid low wages. Of course, this is the wealthiest part of the country. But the pincer movement of higher raw material costs and higher wage costs is inevitably inflationary. Add to that pressure from America on China to revalue its currency and it is clear that the days of China suppressing inflation across the world by producing ever cheaper goods are drawing to a close.
At Heng An, Alan Armitage complains about staff costs. Already he has to pay branch managers in China the same as they would earn as a branch manager in Britain and actuaries more than they would earn in Edinburgh.
China is at that stage of development where it has to move up the quality scale and start to use labour more efficiently. Until now the marginal cost of labour in Chinese factories has been so low that it has been easy to over-employ, encouraged by state authorities desperate to find work for the country’s 1.3 billion population. China now faces difficult times as it tries to satisfy demands for higher wages while at the same time maintaining high employment levels.
No one visiting this country will come away thinking that the Chinese economic revolution is without substance, or that it will not make it through to the next stage of development. But while that transition takes place, there will be times when it will be best for investors to stay away.