On The Bullish Case for China; Why All Types of Saturated Fat Increase the Risk of Heart Disease!

From: aditya rana
Date: Sat, Feb 18, 2017 at 1:38 PM
Subject: On The Bullish Case for China; Why All Types of Saturated Fat Increase the Risk of Heart Disease!
To:

Hi!,

A longer-term focus is of paramount importance for investors, so as not to be swayed by temporary market swings and allowing the fundamental factors supporting a particular investment thesis to play out. Morgan Stanley published an interesting research piece this past week titled “Why we are Bullish on China” which takes a long term view on China’s growth story, analysing its prospects and challenges, and why the MSCI China stock index is likely to continue its outperformance against the broader EM index. Some key highlights:

-The challenges facing China have been well publicised in recent years – a high debt to GDP ratio, excess capacity, over-reliance on investment to drive growth and increasing protectionism. Global investors fear that China could have a major financial shock, like the US is 2008 and Asian EMs in 1997, and are significantly underweight Chinese equities relative to the benchmark (see chart below).

-Morgan Stanley takes a positive view that China will be able to surmount these challenges based on :

1) The risks of a financial shock are low: a) as the debt has been funded by domestic savings and used for investment rather than consumption; b)China has a strong net asset position (and a positive net international investment position of 15% of GDP) which provides a buffer against shocks; c) a current surplus, high FX reserves and lack of high inflationary pressures allowing China to manage domestic liquidity conditions. However, high debt levels reflect borrowing from the future which implies lower growth in the future.

2) Despite lower growth in the years ahead, China is likely to reach high income status (defined as per capita income of $12,500) by 2027 from the current level of $8,100. Only 19 countries have been able to achieve this status over the last 30 years, with Korea and Poland being the only two with populations over 20 million.

-To achieve the above goal, China would need to focus on the following two factors:

1) Manage the debt cycle prudently and allow the economy to grow at its potential rather than at an unsustainable target. Policy makers seemed to have accepted lower growth rates, and have shifted focus on preventing financial risks and asset bubbles. Deflation risks are receding with policy makers directing lower investment in areas with excess capacity, shutting down unviable businesses and a recovery in external demand. Slower growth with easing of disinflationary pressures will reduce the pace of increase in the debt/GDP ratio.

-2) Policy makers will need to implement significant structural reforms in the form of a shift in focus towards consumption and services, further development of the high-value added manufacturing sector, reform of state-owned enterprises (SOEs) and cutting excess capacity.

-China has made significant progress in reorienting its economy towards consumption, which is expected to double over the next decade- rising from $4.4 trillion in 2016 to $ 9.7tn by 2030. China is already the world’s biggest consumer market in various areas (autos, mobile phones, on-line retail) and domestic players are driving the rapid growth is areas like sportswear, cosmetics, budget airlines and hotels.

-Mirroring the shift towards consumption, the service sector is expected to rise to 60% of GDP by 2030, from the current levels of 52%. The growth opportunities are likely to come from areas like business services, real estate, health care, education and personal services.

-Chinese firms are already formidable competitors in heavy industry sectors like telecom equipment, power infrastructure , railway infrastructure and ship construction. Levering the huge size of its domestic market, local firms have a dominant market share in areas like PCs and smartphones. The share of value-added exports has been steadily increasing and now accounts for over half of exports, with good progress made in medium to high technology areas like transistors and LCD screens.

-Reform of the SOE sector is paramount given the high leverage ratios and low ROAs and ROEs levels. Policy makers are focussed on reforms to improve performance – by strengthening the largest SOEs as “national champions”. Progress is also being made in reducing excess capacity in certain areas – with the steel and paper sectors likely being the most successful in reducing capacity.

-Chinese private firms already dominate the MSCI China index in areas like IT, consumer and healthcare sectors, and generate far higher returns than their SOE peers, and could reach 70% of the MSCI China index by 2020.

-Implication of China’s rise to high income status for the world economy:

-China’s move towards high income status will have profound implication for the world – with sectorss benefiting from the growth of domestic consumption and services fuelling opportunities for foreign firms in areas like tourism, healthcare and leisure services. At the same time, a move into higher value-added manufacturing areas, leveraging its huge domestic market and funding capacity for R&D will increasingly pose a threat to upstream manufacturing economies like Korea, Japan, Taiwan and Germany (see chart below).

-Domestic champions like Alibaba, Sinopec, Huawei and Fosun are well on their way to being global multinational companies, while companies like Tencent, Baosteel and Sinopharm have the capability to compete globally. These domestic champions and MNCs are having a significant impact on the overall economy through productivity gains, which will be a key to China’s long term development (see chart below).

-Implications for the stock market:

-If China is able to achieve high income-status in the next decade, it is very likely that MSCI China will continue its outperformance over MSCI EM – which has been 3.0% per annum over the last 15 years (even more against the S&P 500) resulting in a compounded return of 13% per annum versus 10% for MSCI EM (see chart below).

-With the ongoing transition of the Chinese economy, it is recommended to continue being overweight the “new economy” (IT, consumer and healthcare) versus the “old economy” sectors like energy, materials and industrials (see chart below).

-MSCI China has relatively attractive valuations when compared to EM, with a ROE (11.9%) which is 1.5% higher than that of MSCI EM, while its PBV multiple is almost exactly the same (see chart below). In addition, global investors are also about 5.0% underweight Chinese stocks which is close to an all-time low providing room for higher allocations if the investment thesis plays out.

-The onshore Shanghai (+38% from current levels) and Shenzhen markets are also expected to enter a new bull market driven by: a) improved earnings growth (+6%) , P/E ratios increasing to 22x (from 18x currently and a peak of 25x in mid-2015 – see first chart below); investor flows shifting into equities from property with property control measures taking effect (see second chart below).

A well analysed and persuasive case for adding China as a core long term position to a globally diversified portfolio – both from a short-to-medium term perspective (1-3yrs) as well as a long term perspective (10yrs+). There are various ETFs which give exposure to the MSCI global China index (MCHI, CN), China offshore internet (KWEB), Shanghai & Shenzhen CSI 300 index (ASHR), domestic small caps (ASHS), domestic tech (CNXT) and Chinese H shares listed in Hong Kong (2828).

Saturated fat, regardless of type, linked with increased heart disease risk:

An interesting note from Harvard University on new research which illustrates the dangers of saturated fat from all sources – included “healthy” oils like coconut oil:

Harvard School of Public Health, Dec, 2016:

-A study published in the November issue of the British Medical Journal revealed findings that, at first glance, are not that surprising: saturated fat in the diet is associated with an increased risk of heart disease. (1) However, the study offers a unique twist by teasing out the effects of different types of saturated fatty acids (SFAs). Recent articles have attempted to exonerate saturated fat from its long time connection with heart disease, questioning if certain types of SFAs may have a weaker effect on raising blood cholesterol.

-Butter, cheese, red meat, and full-fat dairy are high in saturated fat. Some plant-based fats like coconut and palm oil are also rich in saturated fat. However, all of these foods differ slightly in their relative proportions of individual SFAs. Commonly eaten SFAs include lauric, myristic, palmitic, and stearic. Coconut oil is richest in lauric acid, whereas butter is highest in palmitic acid; both contain smaller amounts of the other fatty acids.

-The BMJ study examined the associations of individual and combined SFA intake with heart disease risk in more than 73,000 women from the Nurses’ Health Study and 42,000 men from the Health Professionals Follow-Up Study. Additionally, the researchers estimated the effects of replacing 1% of daily calories from these fatty acids with the same amount of calories from polyunsaturated fat, monounsaturated fat, whole grain carbohydrates, and plant proteins. There was an 18% greater risk of heart disease in the group consuming the highest amounts of SFAs compared with the group consuming the least, with palmitic acid and stearic acid showing the highest risk. When replacing intake of individual SFAs, the greatest risk reduction was seen when replacing palmitic acid (found in palm oil, fatty cuts of red meat, and dairy fat) with plant proteins or polyunsaturated fat, with an 11% and 12% risk reduction, respectively.

-In the US diet, these SFAs are from some common food sources, such as full-fat dairy, red meats, animal fats, and tropical oils. Therefore, people can lower their intake of these individual SFAs by reducing consumption of those foods high in saturated fats. Our data showed the benefits of switching from saturated fats to healthy polyunsaturated fats, whole grain carbohydrates, and plant-based proteins.

-In diets of the participants, intake of lauric acid was much lower than palmitic acid and stearic acid. This could be the primary reason that they observe clear associations for this SFA. In other clinical trials, the effects of lauric acid on raising LDL are the strongest. Therefore, although small amounts of coconut oil are unlikely to be a problem, it is not desirable to include tropical oils such as coconut oil as a primary source of dietary fat.

Here’s to reducing the intake of saturated fats by cutting down animal protein, dairy, tropical oils and replacing them with plants, whole grains, healthy oils and fruits!

Regards,

Aditya

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