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By Jeremy Glaser | 11-08-2012 04:00 PM

How China's Consumer Sector Will Pay Dividends

As investment in fixed assets declines, consumption will drive GDP growth in China, and consumer cyclicals offer high yields and good valuations, says Matthews Asia's Jesper Madsen.

Jeremy Glaser: For Morningstar, I am Jeremy Glaser. I am speaking today with Jesper Madsen. He is the lead portfolio manager of the Matthews Asia Dividend fund and also the Matthews China Dividend fund.

Jesper, thanks so much for talking with me today.

Jesper Madsen: Well, thank you for having me.

Glaser: Let's start off with talking a little bit about the economy. There has been a lot of talk about a slowdown or potential slowdown in Chinese growth. What are you seeing, or what you're hearing from some of the companies that you follow?

Madsen: It is correct that there is a lot of concern in the marketplace generally about China, and as a result, you can also look at the valuations and see that is very much reflected in I would say a quite cheap valuations for the Chinese equity markets in general. As for the slowdown, this is not a potential slowdown; there is a slowdown in the economy in China, and it's fairly broad-based. However, it is still in the economy that is in spite of this slowdown still growing in excess of 7% a year by the public numbers given. So, again it is something that we're seeing both from a top-down, but also from a bottom-up perspective.

We have seen some impact to more industrial-based companies in China and also those that sell into China in terms of the coal raw materials. China is a large consumer, one of the largest, if not the largest, depending on what category you're looking within base metals and other raw materials. We have seen some impact there as well and that reverberates all the way down to places like Indonesia and Australia for instance. But all that said, we also have to keep in mind that there is very little correlation if none between GDP growth and equity market performance. I know a lot of people, a lot of investors, like to latch on to a headline number like GDP. But what's more important is to understand the composition of GDP growth and also how the company is actually generating earnings and free cash flow behind those numbers, as well.

So, if you look at the composition--and that's what I think is important to not miss sight of in China--much of this slowdown has been engineered. If policymakers in China wanted faster growth, they could have had it, but they've been very targeted in terms of restricting investments in certain parts of the economy, especially real estate. And as a result, they have been very heavy-handed with the banks and the real estate companies trying to shut down some of the flow into that sector. And that is a very important sector in terms of GDP contribution. So, if you look at it, in 2011 about a quarter of the GDP contribution actually came one way another from fixed-asset investments into the real estate sector. So, again it is very much a slowdown that's been engineered and that also means that there is some room for loosening. That's also important to understand that there is room for both fiscal and monetary loosening in a place like China.

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