China watchers would have taken little comfort from this week's economic data showing its economy grew at the slowest pace in more than two years.
The country's gross domestic product in the third quarter grew at 9.1 per cent year on year, down from 9.5 per cent in the second quarter and below analyst forecasts. It was not great news for Australia, given China is its largest trading partner.
The trend, if it continues, will give more ammunition to China pessimists who believe the world's second-largest economy is headed for a hard landing from previous double-digit growth rates.
Prominent American hedge fund manager Jim Chanos has predicted China will end up "like Dubai times 1000, or worse", given its over-investment and empty skyscrapers. There is no shortage of challenges for China: potential property bubbles; weakening exports markets, especially in Europe; rising labour costs and inflation; and some leadership changes next year, to name a few.
Portfolio investors, especially those who hold BHP Billiton and Rio Tinto, must keep a close eye on China. Australian exports there have risen from 6 per cent of our total exports a decade ago to more than 25 per cent today, and strong Chinese demand is a key factor in sharply higher commodity prices in the past few years.
Share valuation service MyClime has published interesting research on China's long-term outlook and what it means for portfolio investors. As markets react to the next newspaper headline and economic noise, MyClime's long-term analysis on China and BHP and Rio valuations stands out.
MyClime's BHP valuation is $50 a share, compared to recent prices near $37. Its Rio valuation is $100 a share. MyClime says: "We don't expect BHP or Rio share prices to hit those valuations this year or next, but the discounts on value make both companies key constituents of a value-focused portfolio.
"Australian investors need not go past BHP and Rio in securing their slice of exposure to the resources boom. Both are well focused on large-scale, world-class, low-cost expandable assets covering the broad spectrum of bulk commodities, metals and energy; and both appear to be cheap based on current and prospective earnings. Both are generating high returns on equity, mountains of free cash flow and have strong balance sheets."
It says regardless of whether China grows at 6 per cent or 9 per cent over the long term, it is "still growing very rapidly". "China will continue to build highways, fast trains, airports and cities at a rapid rate, consuming massive amounts of steel and concrete in the process for years to come," it says.
"Prices of Australian commodity exports will wax and wane based not only on demand, but also on burgeoning supply."
This is the time to balance short-term risk with medium-term probability, it says. "There are likely to be periods where we are facing a softening in demand for our commodities over the next six to 12 months, but over the next three to five years demand is likely to remain strong," it says.
"Of course, a lot will depend on the [commodity] supply response, and producers are in a race to capture market share. For Australia, much depends on the course of economic growth in China over the next few years."
The message is clear: portfolio investors with an investment horizon of at least three to five years should look to continued strong growth in China, perhaps not as strong as in recent years, but enough to make valuations of BHP and Rio at today's share prices look attractive for value-focused investors, according to MyClime.
