Waddell & Reed

Market Perspectives

Waddell & Reed Special Report: China at ground level

Waddell & Reed Advisors Funds Special Report - May 2012

Thomas W. Butch
CEO & President
Ivy Funds Distributor, Inc

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In the second quarter of 2012, Ivy Funds’ sales management team and many of its wholesalers accompanied Ivy Asset Strategy Fund Portfolio Manager Mike Avery, along with Ivy Pacific Opportunities Fund Portfolio Manager Frederick Jiang, on a nine-day trip to a number of cities in China. The trip reflected Ivy Funds’ commitment to provide its sales team an on-the-ground view of China, the observations gained from which would help them be more effective to the financial advisors with whom they work. The following encapsulates the observations of Tom Butch, CEO and president of Ivy Funds Distributor, Inc., who was making his third trip to China since 2007.

You cannot truly appreciate China (its scale, the magnitude and pace of change, the enormity of its diversity) until you see it. Then, once you do, the challenge becomes describing adequately the profound societal change you witness every day there, while avoiding the temptation to draw grand conclusions from the series of photographs you’ve been privileged to snap in your mind’s eye.

Our path took us to Beijing, where the hints of nationalism and national pride lay thick in the air and are manifest in the long lines waiting to visit Mao’s tomb and the reliably large masses that gather at dawn and dusk to see the flag raised and lowered in Ti An Men Square; to Xi’an, the ancient capital, which in 600 AD boasted 1 million residents and was thought to be the world’s most advanced city, now balancing its agricultural heritage with exploding growth and western-style redevelopment; to Dengfeng, a “Tier 6” city (meaning small, relatively, in population and economic clout) whose quality of life greatly exceeded our expectations; and, ultimately, Shanghai, the glittering showcase for the post-modern world.

The social, cultural, ideological underpinnings of each of these areas are no more alike than those of, say, Oklahoma City and Philadelphia. And yet, as within our own country, certain observations span and appear to ring true across the highly diverse environments in which we found ourselves. Following are key insights from our trip. Please review the full pdf document for more detail on each.

Inexorable urbanization

The breakneck urbanization of China continues unabated, across cities of all sizes. At the end of 2011, 51 percent of the Chinese population lived in urban areas, nearly double the urban population of 1990. By 2035, the urban population is projected at 70 percent of the population total.

A burgeoning middle class

Increasingly, this middle class will take on Western habits, including placing value on consumerism and individuality. With income per capita in China growing between 12 and 15 percent per year, the Chinese middle class (generally identified as a family with annual income of between $10,000 to $60,000 USD) is now about 300 million people, not far from the total population of the United States.

Push/pull amid state control, free commerce

The push/pull between an embedded philosophy of state control and an accelerating culture of free commerce and individuality creates challenges, but somehow continues to keep from fraying. The government model, imbalanced and imperfect though it may seem to Westerners, seems to work. We met with many government officials and many entrepreneurs. While they came at economic progress through different lenses, that was their common goal. In fact, the government officials with whom we met were far from the bureaucrats or technocrats one could easily conjure from afar; rather, they seem bound by their common determination (dare I say entrepreneurial spirit) to get things done.

Quality of life issues

As China moves through industrialization, quality of life issues, including environmental concerns, likely will come to the fore. Those visiting Beijing (and, to a lesser extent, the country’s other major cities) for the first time always are taken aback by the air pollution. The veneer of smog in Beijing, principally a result of coal-burning power plants there and in neighboring regions, goes with the turf of industrialization. Many with whom I have traveled adjudge it harshly. In doing so, I believe, they fail to recall the U.S. environment as it industrialized. Pittsburgh, for example, was in the late 19th century described by a visiting journalist as “hell with the lid off;” in the 1940s, when my mother worked downtown, professionals going out for lunch commonly covered their faces with handkerchiefs; and when I was growing up, a light sulfur haze obscured the skyline most every day. Today, of course, smog-free Pittsburgh is among the most picturesque major cities in North America.

China’s cities will no doubt get there as well, in time. A development official in Xi’an spoke unabashedly about accepting the environmental risks that come with attracting certain industries to his area, opining that, at a later time, they would focus on environmental impact.

The unfolding story

It is hard to imagine this story doing other than unfolding constructively over many years. On the ground, it appears to have a long tail. Economists and investment professionals vary in their perceptions of the sustainability of China’s growth miracle. Some worry of a hard landing, others of a less disruptive but still painful slowdown. Time will tell if they are correct; certainly, they could be. But the view from ground level (albeit more instinctual and less quantifiable) renders real the blur of high-growth statistics to which we have become accustomed.

We saw commercial construction everywhere, and yet vacancy rates for commercial space in major cities remains at low single-digit rates. We saw perhaps millions of new housing units built to accommodate ongoing migrations to larger cities, but little to suggest a lack of demand.

We saw, before our eyes, the breakneck unfolding of a new society, with progress and expectation everywhere. In that sense, seeing is believing.

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