China’s Demographic Collapse

I love China stocks as an investment … for the next few years, anyway.

As I wrote recently, Chinese stocks are almost ridiculously cheap at current prices. Plus, the reorganization of the Chinese economy away from investment and export and into “Western-style” domestic consumption should create incredible opportunities for Chinese stocks, as well as for American and European firms selling to the Chinese consumer.

Opportunities to invest in major shifts like this only come around a couple times in a lifetime. I am currently long China and have no immediate plans to sell.

But as bullish as I am on China stocks at this time, investors need to keep the big picture in mind.

Demographics Will Hamper China Stocks

Chinese stocks are a great trade — and I believe a great multiyear trade — but they’re not something you should consider as a long-term investment. China is facing demographic collapse in the decades ahead, and I say this as a sober analyst, not a wild-eyed doom-and-gloomer.

When I speak of “demographic collapse,” I’m not talking about plague, pestilence or a scene from a Mad Max movie. I’m talking about a Japanese-style economic malaise, a prolonged period of slow growth, falling asset values and falling consumer prices.

Like Japan, China has a society that is aging rapidly. By the Chinese government’s own demographic estimates, the number of people above age 60 in China is projected to increase to 437 million, or 30% of the population, by 2050.

Last year, the number was 194 million, or 14.3% of the population.

I know, I know. Life begins at 40, and 60 is the new 30. People are living and staying active far longer than they used to. But underneath this cheery optimism is a far more grim reality. After the age of about 50, consumers in advanced economies tend to spend less of their income and save more, and China’s middle and upper classes will be no different than their Japanese and Western counterparts.

Once you reach a certain age, you already own the largest and most expensive home you ever plan to own, you’ve already paid off the mortgage, and you’ve already furnished it. You continue to spend money on basic necessities and simple luxuries. But your purchases of the large, big-ticket items slow to almost zero.

All else equal, an aging population will mean a stagnating domestic economy and a shrinking tax base … even while government expenditures rise. And as Japan is discovering now — and China will discover in the decades ahead — there is no obvious solution.

Few Answers for China & Others

I recently had a good-natured Twitter argument with fellow InvestorPlace contributor Aaron Levitt. Levitt took the view that, faced with an aging population, China will simply raise its birthrate.


Alas, if only it were that simple.

Raising the birthrate requires young women of childbearing age. And as the following chart should make abundantly clear, potential Chinese mothers are about to be in increasingly short supply:

China demographics

This demographic data comes directly from the United Nations. The number of Chinese women aged 20-24 is already in decline, and the number of women aged 25-29 goes into steep decline starting in 2015.

True enough, women in advanced countries are having children later in life, and Chinese women could follow this trend. But the population of Chinese women aged 30-34 and 35-39 go into steep decline in 2020 and 2025, respectively.

If there is to be a Chinese baby boom, it had better happen fast.

But it’s doubtful that will happen. There is the little problem of the one-child policy, which prevents most urban middle-class Chinese families from having more than one child. And there is the simple reality that, once a society adapts to having a low birthrate, it’s hard to turn that battleship on a dime. Living costs have risen in the cities to the point that large families are not economically viable for the vast majority of Chinese households.

Could the Chinese government implement strong pro-natal policies that economically incentivize Chinese women to have more kids? Maybe, but for several years Russia has been offering cash rewards of $10,000 to mothers for the birth of their second child, and the Russian birthrate is still well below the replacement rate.

And Chinese citizens, having experienced economic freedoms in recent decades, are not as pliant to government decrees as they once were.

Again, I am still wildly bullish on Chinese stocks for the next one to four years. But looking into the decades ahead, China will hit a demographic brick wall — and China stocks will react accordingly.

Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. As of this writing, he did not hold a position in any of the aforementioned securities. Click here to receive his FREE 8-part investing series that will not only show you which sectors will soar, but also which stocks will deliver the highest returns. This series starts Nov. 5 and includes a FREE copy of his 2014 Macro Trend Profit Report.

What’s Next for the Luxury Sector?

The luxury sector has been in the headlines this week, though the outlook has been muddled.  High-end home goods retailer Williams-Sonoma (WSM) beat earnings estimates on Wednesday, initially sending shares higher.  Unfortunately, the details were a lot less impressive.  Overall, sales were up 12.3% and same-store sales were up 8.4%… but the retailer had to lower its prices in order to generate those sales—which lowered margins—and management gave guidance that suggested the rest of the year would be tepid.

This came just a day after luxury jeweler Tiffany & Co (TIF) announced strong earnings and boosted its forecast for the rest of the year.  But—importantly—it was a surge in Chinese sales that pushed Tiffany higher.  U.S. growth was actually a little on the sluggish side.

It’s never a great idea to draw firm conclusions from just two data points, but this has been a recurring theme for most of the summer. Last month, British fashion group Burberry (BURBY), announced a knockout quarter, with sales up 21%.  Growth in China—Burberry’s most important market—were particularly strong.  Across the English Channel, Hermès (France:RMS), the French luxury group best known for its leather goods and scarves, also surprised the Street with stronger-than-expected sales for the quarter led by a strong showing in…you guessed it…China.

American sales have been decent, though far from spectacular. The real success—where there has been success—has been in China.

Between sales in Greater China and sales to Chinese travelers abroad, the Chinese consumer is the engine that drives this entire sector.  European sales have held up fairly well, though this is in large part to aggressive buying by foreign visitors.   Data here is a little hard to come by, as stores generally don’t track the nationality of their patrons.  But as a telling case in point, Chinese visitors make up only about 1% of the traffic in London’s Heathrow airport yet they account for nearly a quarter of all luxury goods sales.

Yet not all news coming out of China is good.  Last month, Rémy Cointreau (REMYF), the maker of high-end French cognac, announced disappointing sales stemming from a sharp decline in China.  Rémy, which makes the ultra-high-end Louis XIII cognac, gets over 40% of its sales from China.  As goes China, as goes the company.

What are we to make of all this?

To start, despite an improving American economy, the luxury story begins and ends with China.  This was bad news earlier this year for certain segments of the sector—such as Swiss watches and super-premium wines and spirits (read: Louis XIII cognac and Chateau Lafite Rothschild wines)—because of a Chinese crackdown on conspicuous consumption and on “gift giving” (ahem…bribery) in government circles.  This was less of a problem for handbag and fashion retailers. As the shock of the crackdown wears off, these segments should recover.  But the short-term hit to sales will be felt in the next round of quarterly earnings releases.

Meanwhile, in other segments of the luxury market, it’s business as usual.  Daimler (DDAIF), the maker of the iconic Mercedes-Benz, just announced that it was making €2 billion in new investments in China.  Daimler plans to double its manufacturing capacity by 2015.

So, with all of this said, should you invest in the luxury sector?

I don’t consider the sector the screaming bargain that I did a year ago, but I still see quite a bit that I like.  Daimler is one of my favorite stocks (and my choice in InvestorPlace’s Best Stocks of 2013 contest…which it happens to be winning at time of writing).  Daimler is up over 30% this year, including dividends, yet the stock still trades for a very attractive 8 times earnings.  It also sports a respectable 4.2% dividend.

I also like Swiss watch leader Swatch Group (SWGAY).  In addition to its own highly-successful brands–such as the Omega worn by James Bond–Swatch also makes the “guts” that go into 90% of all high-end Swiss watches. Swatch trades for 17 times earnings and yields 1.24%.

China’s growth looks to be stabilizing at around 7.5%.  The days when Western luxury firms could count on 20% per year annual sales growth are probably over, but the “luxury story” will remain the “China story” for the foreseeable future.

Charles Lewis Sizemore, CFA, is the editor of the Sizemore Investment Letter and the chief investment officer of investments firm Sizemore Capital Management. As of this writing, he was long DDAIF and SWGAY. Click here to learn about his top 5 global investing trends and get your copy of “The Top 5 Million Dollar Trends of 2013.”

What’s Next for the Chinese Renminbi…and What Does it Mean for Investors

If you are to believe U.S. politicians and talk radio hosts, China’s renminbi is managed by a sinister cabal of James Bond villains who intentionally suppress the value of the currency to give their manufacturers an advantage and to hollow-out U.S. manufacturing.

 US Dollar – Chinese Renminbi Exchange Rate

While that view of China’s ruling Communist Party isn’t completely fantastical, the truth is a little more complicated. When China’s leaders decided in the 1980s that “to get rich is glorious,” they decided that a weak currency was a convenient way to make that happen.  From a value of 1.50 yuan per dollar in 1980, the renminbi fell to nearly 9 yuan per dollar before China instituted a peg at 8.27.  The renminbi was pegged at that level from 1997 until 2005, when—pressured by the United States and other trading partners—China opted for a managed float that would allow for a gradual rise.

The precise rules that control the float have changed multiple times as China has become more lenient, and currently the price of the renminbi is allowed to fluctuate within a daily 1% band against a basket of major world currencies.

(Note: I’m often asked why China’s currency has two names: the renminbi and the yuan.  “Renminbi” is the currency’s official name.  “Yuan” is a unit of renminbi.  The price you see quoted in a Chinese store would be, say, 5 yuan.  You would never see a price quoted as 5 renminbi.  This is not too different than the British pound sterling.  “Pound sterling” is the currency’s name, but prices in the UK are quoted in pounds, not sterling.)

As a country with a massive export economy and the largest current account surplus in the world—$214 billion as of 2012—China’s currency should naturally appreciate in value due to market forces (all else equal, a large trade surplus leads to a rising currency as it, in effect, involves selling the currency of the importing country to buy the currency of the exporting country).

And indeed, the renminbi has been gaining on the dollar since it was de-pegged.

Not entirely coincidentally, China has also become less competitive as a manufacturer.  In fact, just this week one of China’s leading shoemakers moved part of its manufacturing base to Africa to take advantage of the lower costs!

The rising value of China’s currency is certainly part of the reason for China’s loss of competitiveness.  A bigger issue—and one for which there is no easy solution—is the rising cost of Chinese labor, which is growing at a double-digit clip.

China’s manufacturing model assumes an inexhaustible supply of cheap migrant labor from the countryside.  But after 30 years of growth—and over 30 years of the One Child Policy—the pool of labor is simply no longer there to exploit.  This means that China will have to invest more in capital in order to boost competitiveness…or simply massively devalue its currency again.

There is a big problem with that second option.  China’s leaders are already worried about inflation, and they are reluctant to do anything that will fan those flames.  And China’s middle classes—which become more assertive every day—are less likely to tolerate high inflation or higher prices for imported goods.

If the Chinese Communist Party wants to keep its grip on power, it has to keep its restive masses happy.  And this means that any devaluation of the renminbi will be gradual, if it happens at all.

What does any of this mean for investors?

If you are going to invest in China, invest in companies that benefit from rising living standards among Chinese workers.  Go for consumer goods and services rather than industrial companies and exporters.

China Mobile ($CHL) is a fine example. China Mobile is the largest mobile phone operator in the world by subscribers, and as Chinese consumers trade up from feature phones to smart phones, the company is well positioned to benefit.  It also trades for just 10 times earnings and yields 4% in dividends.

China will eventually “blow up,” as its aging demographics and persistent asset bubbles virtually guarantee a Japanese-style malaise.  But in the meantime, there is still money to be made investing in the Chinese consumer.

Sizemore Capital is long CHL. This article first appeared on InvestorPlace.

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VIDEO: China, Japan and their Demographic Time Bombs

China made waves with a bad manufacturing report this week, sending world equities–and particularly Japanese equities–sharply lower. But the issues in Asia go beyond just exports and currency rates. It’s about plummeting birth rates and demographics, and what it means for Chinese and Japanese investments. Jeff Reeves of and I talk things over.

As I mentioned on the video, I would run away from Japan screaming right now, or at least I would run away screaming from Japanese equities.  The short yen / long Japanese equity trade has been the most profitable macro trade in recent years, but it is a short-term trade supported with very weak fundamentals. The next fortune to be made in Japan will likely be in shorting its bonds.

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It’s Time to Buy China

The past two years have been volatile for investors in virtually every market, but they have been particularly unkind to investors in China.  Chinese stocks, as measured by the iShares FTSE China 25 Index ETF (NYSE:$FXI) spent most of 2011 and 2012 in a downtrend, though in the past two months they have shown signs of life.

Should investors take this rally seriously?  Or is it yet another fake out destined to burn them?

Right now, the upside potential in China far outweighs the downside.  China is a buy.

You’re probably raising your eyebrow right now, but hear me out.  China is one of the cheapest markets in the world right now.  Chinese stocks trade for just 7 times earnings, less than half the valuation of American stocks as measured by the S&P 500.  And at the same time, sentiment towards China is downright horrid.  It’s hard to find anyone who is actually bullish on China these days.  A Google search for “China” and “hard landing” returned over 3 million hits.

I know, I know.  You can’t take Chinese earnings seriously because they cook their books.  Fair enough.  I actually agree that you have to take most Chinese data releases with a grain of salt.  But many of FXI’s core holdings—such as China Mobile (NYSE:$CHL), the largest mobile phone company in the world by subscribers—trade in the United States as ADRs and meet international reporting standards.  And when they are priced as cheaply as they are today, there is certainly margin for error if earnings reports are a little on the aggressive side.

Furthermore, the macro picture in China—which was never nearly as bad as the media hysteria would have suggested—appears to be stabilizing.  The China Manufacturing Purchasing Managers Index improved in November—the first improvement in 13 months—and profit among Chinese industrial companies rose 21% last month.

China is still far too dependent on capital spending and exports; for the country to have anything resembling a balanced economy it needs to see the consumer sector playing a more prominent role.  But for now, I am comfortable investing in China.

Buy FXI at market.  But use a stop loss or a trailing stop to protect yourself in the even that investors get spooked again and send shares lower.  While I am bullish on China at this time, a Eurozone “blow up” or a turn for the worse here in the U.S. could spill over into the Chinese market.  A 15-20% trailing stop should be sufficient for now.

If investors “rediscover” China, we could see 50-100% gains over the next 12-24 months if recent history is any guide.

Sizemore Capital has no positions in the stocks mentioned. This article first appeared on TraderPlanet.