Brenda Vingiello, Sand Hill’s Chief Investment Officer, joined Squawk Box to discuss her thoughts on the latest market trends and market outlook for 2025. This
Emerging Markets “Hukou Economics”
Published Date : January 17, 2014
While domestic markets reached all-time highs in 2013, emerging markets stumbled and declined just over 2% for the year in comparison to the 27% returns in international developed markets. On an absolute basis this doesn’t seem so bad but, looking back at history, the last time a performance differential between emerging and developed markets this wide occurred was in 1998 during the Russian debt crisis. So, without a specific crisis, why did emerging markets perform so poorly? The year brought many changes including a shift in accommodative policy from the Federal Reserve, which caused a significant change in sentiment toward the group. When combined with weaker exports, lower commodity prices, weakening currencies and capital outflows, these countries experienced what some would term a “perfect storm.” As a result, the market has reset expectations. While it’s true that growth has moderated and the group continues to face structural headwinds, many forward indicators are starting to stabilize. One area of tremendous interest to us is policy support for China, the largest and most significant component of your emerging markets exposure.
A policy item we are watching closely on your behalf is China’s household registration system, called hukou, which was implemented during the 1950s as a method to control population movement from rural areas to urban areas. Each citizen has access to social benefits such as education, housing and medical security as long as they remain in the region in which they’re registered. When workers move from rural areas to cities in search of better jobs they become unregistered and are no longer entitled to public services. It is estimated that approximately 20% of China’s population is living in unregistered households, forced to save a disproportionate amount of money for education, health care expenses and other potential emergencies. This has contributed to China’s very high savings rate, currently estimated at 38%, which compares to the U.S at just 3.9%.
During China’s Third Plenary Session, the government announced plans to accelerate hukou reform by relaxing rules relating to residency transfer as well as allowing rural residents to gain access to social services in smaller cities. The registration system will likely still remain in the country’s most populous cities, such as Beijing, as a method of controlling overcrowding. By some estimates, an increase in consumption by unregistered households previously denied benefits under hukou laws, could increase GDP by as much as 3%. Consumption in China drives an estimated 35% of GDP compared to the U.S. economy where consumption drives 71% of GDP. While this transformation will take time, it is directionally supportive of the growth of the middle class in China.
Following a moderation of growth in the fourth quarter of 2013, we expect economic growth in China to stabilize in early 2014. The government is currently targeting GDP growth of 7-7.5%; however, economic growth could accelerate beyond 8% in the coming quarters as a result of policy support from the government, as well as a continued pick up in global external demand. While market sentiment is heavily reflective of many of the emerging market countries’ challenges, we view the relative economic growth, and rise of the middle class as an attractive long-term investment opportunity. This led to our investment in emerging markets following the relative underperformance of the asset class during 2013 and demonstrates our disciplined investment process and long term contrarian approach.
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