Is China’s Investment Boom Sustainable? [iShares FTSE/Xinhua China 25 Index (ETF), ProShares UltraShort FTSE China 50]

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April 9, 2015 4:41pm NYSE:FXI NYSE:FXP

china etfsMike Burnick: The International Monetary Fund (IMF) released the latest update to its World Economic Outlook this week saying that worldwide growth potential may not live up to previous expectations.

In today’s slow-growth world where deflation still has a death-grip on economies in Japan and much of Europe, this “news” should really come as no surprise. But what’s interesting is the consistent and growing gap between the emerging and developed world.

After the global financial crisis, global economic output dropped sharply below trend in 2007 and 2008. And the recovery from the slowdown has been uneven at best. What’s worse, this downshift in growth is likely to persist for years into the future, according to the IMF, which means interest rates could also remain lower for longer than most people think.

The disparity in the global recovery also highlights where some of the best profit opportunities can be found today: In faster growing emerging markets, particularly Asia!

Potential economic growth measures a nation’s ability to expand over time without triggering higher inflation. Growth potential was already slowing in developed nations like the U.S., Europe and Japan even prior to the crisis, due to a combination of aging populations, plus declining productivity and innovation.

But according to the IMF study, a lack of private sector investment has placed the developing world on a path toward much slower growth for many years to come (see graph below).

Click image for larger view

Overall investment spending has plunged 25 percent from the pre-crisis trend in the advanced economies, with slumping business investment accounting for about two-thirds of that decline.

As a result, growth potential may be limited to just 1.6 percent over the next five years in advanced economies, well below pre-crisis growth rates. And the IMF notes that due to slack demand in Europe and Japan, potential growth could turn out to be even lower than these already dismal forecasts!

On the other hand, for emerging markets it’s a very different story, with a much happier ending.

As shown in the graph above (left panel) private sector investment in the emerging world remains strong, at the high-end of the projected range even before the financial crisis, while investment in the world’s major advanced economies it is still well below trend.

Potential economic growth in the emerging world did slip to 6.5 percent annually after 2008, down just slightly from a pre-crisis level of about 8.5 percent. And going forward, emerging market growth potential could slip a bit more, to 5.2 percent annually, but that’s still more than three-times better than advanced economies!

Business investment has played a major role in helping to sustain growth rates in emerging markets, particularly in China and surrounding Asian nations.

Click image for larger view

A combination of fiscal policy stimulus from China and other Asian nations in response to the financial crisis has helped boost investment in emerging markets.

And in more recent years, a growing share of global trade and strong capital inflows to the emerging world have sustained the uptrend in investment spending.

In fact, investment spending in China (chart above, right panel) is expanding at an above-trend growth rate, compared to pre-crisis projections.

All of this bodes well for China’s economy and stock market over the long run, as I pointed out last week.

Yesterday alone the iShares China Large-Cap ETF (FXI), which I mentioned last week, jumped 5.9 percent — its biggest gain since 2011. It’s hard to say how much the IMF report had to do with this move.

A more likely explanation is that investors are expecting more interest rate cuts and monetary stimulus to come from the People’s Bank of China. Stay tuned!

This article is brought to you courtesy of Mike Burnick.

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