Morningstar Advisor - December/January 2012 - (Page 36)

Spotlight Exhibit 3 Overbuilt: China’s expressways nearly equal the U.S.’s in miles, with one third the cars. Country Expressway miles Number of vehicles Miles/1,000 vehicles building more expressways at a rate comparable to what we’ve seen in the past 10 years is very limited. The biggest contributor to China’s fixed-asset investment boom, particularly in the past few years, has been residential real estate. Throughout the 2000s, China built housing at a truly blistering pace, adding a cumulative 120 square feet in residential floor space per person from 2001 to 2010 (Exhibit 4). This year alone, China will add nearly 18 square feet in residential floor space per person. In some respects, this housing boom is understandable, given the significant additions China made to its urban population over the period. What is less understandable is the roughly 80% surge in the rate of floor space additions we’ve seen in the past few years, which has not been accompanied by a comparable surge in urbanization. At present, on a per-capita basis, China now has nearly five times the amount of residential floor space under construction as peak-housingboom United States. This is particularly remarkable because, despite enormous gains in wealth and income, the Chinese remain on average much poorer than their American counterparts, and they tend to occupy residences that are much smaller. 33 New Yorks China United States Germany Japan 45,554 46,876 7,962 4,748 78 million 240 million 59 million 74 million 0.58 0.20 0.14 0.06 Sources: Wards; NBS; U.S. Federal Highway Admin.; Japan Ministry of Land, Infrastructure, Transport and Tourism; Eurostat; Morningstar While the notion of “33 New Yorks” is intuitively powerful, we’d strongly caution investors against taking the data underpinning the “stronger for longer” urbanization story at face value. That’s because countries use very different definitions of what constitutes urban. As a result, relying on headline data alone can lead to ill-informed conclusions. Consider the fact that China’s self-reported urban share of 50% is equivalent to reported figures from Ghana (50.7%) and apparently well below that of North Korea (60.1%), which remains largely a subsistence agriculture economy. As it turns out, China’s definition of urban is stricter than most, effectively portraying the country as more rural than it might otherwise appear and potentially overstating the remaining runway for further urbanization. China’s statistics bureau generally requires a density of 1,500 people per square kilometer for a population cohort to be deemed urban. By this hurdle rate, four of the top 10 largest U.S. cities would fail to meet China’s definition of urban, not to mention hundreds of suburbs. While the granular data necessary to reformulate China’s urban/rural breakdown on a more apples-to-apples basis with that of the United States isn’t made available, it seems fair to assume that such an undertaking might add at least 10 percentage points to China’s urbanization level, significantly curtailing the urbanization upside promoted by China bulls. Paths to Rebalancing Exhibit 4 Housing Boom: China’s residential floor space has surged every year since 2000. Year Added square feet per capita 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Sources: NBS, Morningstar estimates 11.4 11.0 11.2 10.8 10.3 10.9 10.8 11.9 12.9 14.9 15.5 17.6 China’s expressways, called the National Trunk Highway System, look overbuilt (Exhibit 3). By year-end 2011, the highway system will have quintupled its 2000 length. Heading into the year, the total length of China’s highways (45,554 miles) was already on par with that of the U.S. Interstate Highway System (46,876 miles), a country of similar geographic size, but with three times as many cars on the road. While growing Chinese vehicle ownership rates are likely to trim some of the bloat in the next couple of decades, the rationale for Perhaps the biggest counterargument to the overbuilding thesis goes as follows: Despite the massive urbanization of the past couple of decades, China remains rural by global standards and will continue to require large additions to its capital stock as it accommodates new urbanites. According to Chinese government figures, even after an influx of 207 million new urban residents in the past decade, only 50% of the population resides in urban areas (Exhibit 5). An increase to 70% urban, a level typical of the high middle-income status to which China aspires, would add another 272 million to China’s urban total. That’s equivalent to adding 33 cities the size of New York. All told, we expect to see significantly lower GCF growth in the coming decade than China had in the decade just past. As a result, for China to sustain robust economic growth over the next 10 years, household consumption will need to grow at above-trend rates. In effect, China will need to rebalance its economy toward a more normal composition of consumption and investment. Chinese policymakers are not blind to the need to increase consumption. Government officials recently said that their objective is to 36 Morningstar Advisor December/January 2012

Table of Contents for the Digital Edition of Morningstar Advisor - December/January 2012

Morningstar Advisor - December/January 2012
Contents
Contributors
Letter From the Editor
Seduced by Complexity
Is China Exposure Important for a Portfolio?
A Niche Built on Trust
How to Find Your Client’s Investment Style
Taking the Long View
Consensus on Europe Elusive
Four Picks for the Present
Investment Briefs
Is Perception Reality for Active Managers?
Be Alert for Basic-Materials Bargains
Investment Boom Unsustainable
Digging Moats in China
Where China’s Domestic Companies Stand to Benefit
Arising Opportunities
China Strong Long Term
From Currency Manipulation to International Acceptance
The Keys to China’s Fortune
Wedgewood’s Lessons Pay Off
Reading the Evidence on Indexing
Scouting for Investments Abroad
Yield, Please (Hold the Europe)
Mutual Fund Analyst Picks
50 Most Popular ETFs
Undervalued Stocks With Wide Moats
China Fund Managers Eat Elsewhere

Morningstar Advisor - December/January 2012