#$dsum

Your first question might be: “what the heck is the “Internet of Cars?!” It’s a fair one. The Internet of Vehicles (IoV) just might be the next milestone in the tech zeitgeist, with designs to integrate vehicle-to-vehicle, vehicle-to-roads, vehicle-to-human and vehicle-to-sensor mobile interactions. The internet-based technology is expected to equip vehicle users with better and easier-to-use navigation, road safety and location sharing tools along with other functionalities of their smartphones including entertainment apps, web browsing and (hands free) calls. Sounds like something that should be coming from Silicon Valley, but in actuality it is China that could be emerging as one of the biggest forces at its forefront.

Currently ranking as the largest market for automobiles—with 24.6 million units sold in 2015—along with having the highest number of internet users in the world, China is ripe for securing a hefty slice of the IoV revolution. And it’s already well underway.

Already, several Chinese internet/technology companies have embarked on clinching deals with the biggest automobile firms in the world. Chinese internet behemoth Baidu has managed to get automakers including Hyundai, BMW, Mercedes, Ford, Audi and Volkswagen to install its ‘CarLife’ in their units sold in China. The search engine company also teamed up with an insurer for a usage-based auto insurance project.

In 2014, Alibaba purchased Chinese interactive mapping and navigation firm Autonavi for $1.5 billion, and is looking forward to joining hands with Chinese automaker SAIC. Also, Audi has revealed plans of incorporating Chinese internet company Tencent’s WeChat app into its vehicles to allow location sharing. French automobile maker PSA Peugeot-Citroen will reportedly collaborate with Alibaba for wi-fi features in their cars sold in China, and is also planning to install apps to detect gas usage and vehicle location.

The “connected vehicle” market also spells ample opportunity for mobile service providers. Connectivity features in cars could require more data usage and faster internet speed—meaning more revenue-earning avenues would be available for internet/cellular service providers. To cash-in on this promising market, China Mobile and Deutsche Telecom partnered in October 2014 to provide 4G-based vehicle information services to connected drivers.

China to Take-On U.S. Tech Giants

According to estimates by Statista, the number of connected cars in China would touch more than 44 million by 2020, and would therefore surpass the estimated U.S. levels of around 31.8 million. Revenues in the connected car market are expected to grow at CAGR +44.9% in China over 2016-2020, which is significantly faster than the +27.6% predicted for the U.S. market.

Fuelled by a growing tech-savvy domestic population (around 60% of Chinese customers are willing to change car brands for better connectivity features as revealed by a McKinsey survey) coupled with regulatory curbs on foreign technology (such as those on Google Maps and Apple’s iBooks and iTunes movies), Chinese tech firms can potentially give a tough competition to their foreign counterparts in its domestic market. The ‘Made in China 2025’ government initiative unveiled last year stated goals to boost domestic technology and innovation in China, which included 80 percent of domestic automobile entertainment systems and 100 percent of the nation’s satellite navigation system market, to be owned by Chinese companies by 2030.

Furthermore, with the possible expansion of China-made car exports in emerging regions like Africa and Asia, in addition to an expected development of its own operating system (akin to Ios/Android), China’s footprints in the internet-connected ecosystem could transcend borders in coming years. That could add to the competition among global powers in the tech space.

Bottom Line for Investors

Armed with government support to stem entry of foreign players, China’s domestic technology sector is brimming with potential for the automobile space, exacerbated even more so by a large and growing tech-savvy consumer base. But that’s not to say that the U.S. technology industry is doomed under Chinese competition.

For one, China’s prosperity in the tech-auto sector would likely be more concentrated in its domestic market, potentially leaving the long-standing U.S. technologies to cater to a larger and rapidly growing global market, just as the U.S. successfully did after websites like Google were blocked by China.

Globally, more than 97% of the smartphone market comprises iOS and Android operating systems—something that could likely be translated into consumers’ choice of connectivity systems on their car dashboards. Moreover, in China millions of customers who are long accustomed to using Apple or Android products on their smartphones may not be willing to change so easily.

Something to keep an eye on will be how quickly U.S. tech companies bring innovative and remarkable products to market, and who creates the superior applications. So far, the U.S. has proven time and again to have the best and deepest ability to shape the landscape, and China’s isolationist approach may just be the thing to keep it that way.

FREE Download – Zacks Economic Outlook

At a quick glance, China’s economic growth is decelerating. However, this may just be a temporary “side-effect” of the nation’s re-making itself as a services-oriented economy from that of a manufacturing behemoth.

Looking back at U.S. history, this evolution in China’s economy is not unlike that of the U.S. which started as an agricultural based economy, morphed into a giant of industry and is now an envied service and consumption based economy. As these changes proved successful in the U.S., could this be China’s roadmap to prosperity as well?

The Chinese manufacturing industry’s epic success—contributing to an average +10% GDP growth in the nation over the last couple of decades—was primarily the result of demand from advanced economies, fueled by China’s low-cost exports. But, that market can’t be expected to continue growing at the same pace forever, especially with overcapacity creeping up in various sectors.  

    Data source: World Bank

     Data source: World Bank

With all the capacity generated by China’s investments in fixed assets, the nation would need a market for an additional output ranging between $5 trillion and $7 trillion (in constant 2009 prices) every year through 2020—as suggested by a 2010 study.  That’s something which already saturated foreign demand alone is not likely to accomplish.

China to Turn ‘Inward’

Notwithstanding China’s citizen headcount exceeding 1 billion, its consumption expenditure share in GDP stood at only 35.9% in 2010 (versus America’s nearly 309 million population’s consumption contributing around 70% of its GDP). That, in addition to a sated foreign market, could have guided Chinese policymakers to turn ‘inward’—as evident from China’s 12th (2011-2015) and 13th (2016-2020) five-year plans—and focus more on capturing their own domestic market to set the wheels in motion for longer-lasting growth.

With a goal to strengthen household purchasing power and improve quality of life, Chinese authorities have planned to improve service industries including health, education, finance, technological innovation, logistics/transport and tourism. Additionally, focus will be put on equitable income and resource distribution as well as creating environmentally-friendly technologies.

It appears the restructuring is already gaining traction. In 2015, slowing industrial growth was accompanied by a strengthening services sector, with the latter growing at +8.3% (up from 2014’s +7.8%). Services sector share rose to 50.5% from the preceding year’s 48.1%, contributing to more than half of China’s GDP for the first time (while Manufacturing share slid more than two percentage points to 40.5%).

Additionally, in 2014, China’s domestic consumption growth accelerated to more than +9%, from the preceding year’s +7.5%. The share of consumer spending increased 1.2 percentage points to reach 37.4% the same year.

          Data source: World Bank

Furthermore, the People’s Bank of China’s accommodative policies, such as a record-low lending rate of 4.35% since October and reserve-requirement reductions, have facilitated new loans of 1.38 trillion Yuan this June, beating estimates. Bank deposits and currency in circulation collectively soared +24.6% in June from a year ago, registering the biggest jump in six years.

China’s Restructuring Reminiscent of America’s Transition

China’s restructuring is reminiscent of America’s economic history, although the two are separated by somewhat different sets of driving forces.

The industrial revolution in the U.S., whose first phase spanned the period of 1790 through the 1830s, marked the economy’s transition from agricultural to industry. While China is teetering on overcapacity in manufacturing/heavy industry at present, America was experiencing an abundance of land, far outstripping labor availability, which probably galvanized the nation to switch to machines from manual work for higher productivity. The revolution set the stage for the “factory system” characterized by mass output production from centralized locations, akin to China’s manufacturing success story.

In the post-World War II period, industrial output growth in the U.S. was fast outpacing demand. On the other hand, the higher productivity had already translated into higher wage rates and profits, meaning American consumers had more purchasing power for services. So, to adjust to the situation, employment shifted from the industrial sector to services. Later on, in the late-1970s and ‘80s, Japan and, subsequently, China emerged as strong global competitors to American manufacturing, driving the U.S. further toward a services and consumption-oriented economy. China’s restructuring, however, has less to do with foreign competition than saturated foreign demand for its manufactured products; a largely untapped domestic market only adds to the impetus behind the changeover.

Bottom Line for Investors

China’s reshuffling of economic objectives constitutes a paradigm shift from its decades-old growth engine. And, therefore, it could face some temporary hiccups, such as slackening growth in the initial years of the restructuring process. Nevertheless, these steps are necessary to rein in the Chinese economy’s ‘over-dependence’ on external markets and to become more self-sufficient to mitigate vulnerabilities from external shocks.

Should the nation successfully achieve the restructuring objectives, China could emerge as the next economic superpower, capitalizing on its burgeoning urban populace.

Download – Zacks Economic Outlook: July, 2016

Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. Zacks Investment Management, Inc. is a wholly-owned subsidiary of Zacks Investment Research. Zacks Investment Management is an independent Registered Investment Advisory firm and acts an investment manager for individuals and institutions. Zacks Investment Research is a provider of earnings data and other financial data to institutions and to individuals.

As Britain suffers downward market volatility following the Brexit vote, global travelers are scooping up bargains–all thanks to a declining pound. This holds particularly true for tourists from China–in aggregate, the largest consumer of global luxury goods and services.

Shortly after the Brexit vote, would-be Chinese travelers flocked to travel agencies’ websites to check out U.K. holiday booking options. Chinese visitors made ~270,000 trips to the U.K. in 2015; a +46% increase for the year, according to tourism website VisitBritain. It appears this figure may jump again. 

According to CTrip.com, China’s largest travel agency, searches almost tripled on its booking app as U.K. summer vacation costs dropped by about one-third following the pound’s decline. This could lead to a surge in Chinese purchases of British goods and services as China ranks among the fastest-growing consumers of luxury brands. Additionally, Chinese consumers obtain  almost 80% of its high-end purchases from outside the “Mainland ” (as suggested by a 2015 study from Bain & Company).

This could bring relief for British brands like Burberry, for example, as 60% of its U.K. revenues come from tourists, per Citigroup estimates. In fact, a MainFirst Bank AG analyst suggests that a 10 percent decline in the sterling could raise Burberry’s pre-tax profits by as much as 90 million pounds.

Gains in Britain’s high-end market could impact retailer counterparts in Japan and Hong Kong, especially with the regions’ currency dynamics at present. A study reveals that shifting travel preferences from Japan to Europe and the U.K. could result in a 40% cost savings for Chinese shoppers  (source – Bloomberg). The Brexit situation will likely spur investors to pour money into the yen—a “safe haven”—which, in turn, would make Japanese goods even pricier and British goods relatively more attractive to big spenders on luxuries, like the Chinese.

Bottom Line for Investors

The prospect of Chinese tourists cashing-in on the pound sterling’s decline could emerge as a salve on the wound inflicted by the Brexit vote. Though time is needed for evaluation, the drop in value of the pound appears it could help the U.K., at least marginally in the short term.

FREE Download – Zacks Economic Outlook: July, 2016

Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. Zacks Investment Management, Inc. is a wholly-owned subsidiary of Zacks Investment Research. Zacks Investment Management is an independent Registered Investment Advisory firm and acts an investment manager for individuals and institutions. Zacks Investment Research is a provider of earnings data and other financial data to institutions and to individuals.

China’s total debt rose to a record of 237% of gross domestic product (GDP) in the first quarter of 2016  and now exceeds that of its Emerging Market counterpart, India.

In the first quarter alone new debt increased by 6.2 trillion renminbi, marking the biggest three-month surge on record and a 50% increase over last year's pace.  

Even with the backdrop of mounting debt, the Chinese economy has managed to meet its economic growth target of ~7%. But, a closer look reveals that overall credit grew much faster than nominal GDP in the last year, resulting in an excessive debt burden for the economy.

What Led to Mounting Chinese Debt?

In order to keep the economy chugging along, the government embarked on a credit crusade following the financial crisis. This raised China’s total net debt to $25 trillion renminbi by the end of Q1 2016  (including both domestic and foreign borrowing). The problem is that it never stopped borrowing.

In the beginning of 2009, new loans grew by 95%, but following the financial crisis the government started offering cheap credit to a number of companies to build apartments for urban migrants, airports for the newly affluent and roads to accommodate a fleet of new cars.

This, in essence, is what led to loan growth at twice the rate of gross domestic product. The spigots have remained open, and bad loans are said to have doubled in the past two years and now represent 5.5% of banks’ total lending. Interest on existing loans has also mounted to the point where borrowed money is needed to finance payments due. It’s been reported (in the Economist) that in 2014, 160 of the 1,000 largest Chinese firms owed more in interest than they earned before tax.

Bottom line for Investors

Many economists are of the opinion that while the size of country's debt is a serious concern for the global economy, more worrisome is the speed at which it has accumulated. History shows, in many cases, that major economies that experience rapid increases in debt-to-GDP ratios have suffered either a financial crisis or a prolonged slowdown in GDP growth.

Chinese policymakers are saying they recognize the problem and that necessary steps are being taken, but if a global slowdown or recession mixes with the wrong kind of policy it could mean some kind of judgment day. Even if the People’s Bank of China is able to safeguard the economy from such an event—which they’ve been able to do so far—long-term high debt levels could result in a Japan-style slowdown and recession that would drag on for decades.

The fact that China had been able to overcome, through growth, from a similar problem a decade ago gives a glimmer of hope. But, the government would be well-served to take aim at more structural solutions to the problem versus short-term solutions like debt-for-equity swaps and loan rollovers. Those are Band-Aids that simply won’t hold for long in the current scenario. It’s a problem world governments and investors alike should keep an eye on.

FREE Download – Zacks Economic Outlook: June, 2016

Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. Zacks Investment Management, Inc. is a wholly-owned subsidiary of Zacks Investment Research. Zacks Investment Management is an independent Registered Investment Advisory firm and acts an investment manager for individuals and institutions. Zacks Investment Research is a provider of earnings data and other financial data to institutions and to individuals.

Each year brings new mutterings that China is interested in methodically dismantling currency controls that keep the yuan pegged to the dollar, with the eventual goal of making the yuan a (more) freely convertible currency.

It’s a wonderful thought but, to be fair, we’re probably still a long way off from that happening. China initiated a currency peg to the U.S. dollar back in 1994 in an effort to secure their spot as the world’s leading exporter. With a weak yuan, China’s exports have remained competitive on a global level and, developed countries like the U.S., have exported hundreds of thousands (perhaps millions) of low-skilled manufacturing jobs there as a result.

What’s lost in domestic manufacturing for developed countries, like the U.S., is gained in cheaper imports of goods and the cheaper manufacture of higher-end goods (since some parts are sourced and built in Chinese plants then brought back to the U.S. for final assembly).

It’s not a perfect model and, politically, it’s a sticky issue (since jobs are lost). But, all things considered, there’s a net economic benefit—the U.S. (and global) consumer gets lower prices and the Chinese economy has seen blistering growth over the last 30 years. Taken together, this has provided an overall boost to the global economy and lifted a lot of other ships with it, like Emerging Markets economies and stock prices.

Some of you might be thinking, sure, but isn’t this still just plain and simple unfair trade? China manipulated its currency to keep its goods hyper-cheap, relative to the world, and essentially created a monopoly on manufacturing in the process. A lot of people here are out of work as a result.

This is true, and it’s why the U.S. has put political pressure on China over the last decade to allow its currency to appreciate – something I believe China should absolutely do. But at this stage, we have to also be very careful about “biting the hand that feeds us,” so to speak. A rapid appreciation of the yuan could mean goods made in China become more expensive, a cost that will likely get passed to consumers (you). Additionally, a stronger yuan would mean a slowdown of Chinese manufacturing, which makes up over 25% of its economy. If China weakens substantially, the global economy will feel it, and it could hurt global growth and stock prices.

If it sounds like a Catch-22, it’s because it is. But it’s only a Catch-22 if the yuan rapidly and sharply appreciates against the dollar. What I would rather see is a gradual move toward greater flexibility, much like China started back in 2010. By some estimates, the yuan could be undervalued by 25%, so moving the trading band by a few percentages each year could be a smart solution to leveling the playing field, and to making removal of the peg easier when that day finally comes. Currency hardliners would like to think that the solution is as simple as, "let the currency float and the free market will handle the rest.” But it’s not that simple — considering these pros and cons below will underscore why:

Pros to Letting the Yuan Float:

Helps U.S. Exports – and European exports, for that matter. If the playing field is leveled suddenly, China may not be the best solution for cheap goods and production (and the attractiveness of U.S. and European goods inherently rises). That could even lead to some manufacturing jobs returning to the U.S.

Promotes New Types of Investment in China – if China and multinationals lose their “subsidy” for expanding the manufacturing sector, it could free up capital for investment in other areas (like expanding the service economy and promoting domestic consumption).

Empowers the Chinese Consumer – speaking of domestic consumption, the middle class in China is one of the fastest growing demographics in the world. If their currency goes a longer way towards purchasing goods in the global economy, everybody wins.

Creates New Wealth for Emerging Industrial Countries – if the cost of manufacturing in China rises with a rising yuan, it could open new doors for other industrial nations with cheap labor, like Mexico and Vietnam. If there’s one thing you can be fairly certain of, it’s that multinationals will find a place with cheaper cost of production and move there. Doing so could help an emerging economy really gain steam, and create new wealth.

Cons to a Rapidly Appreciating Yuan:

Chinese Exports Hurt – If the manufacturing boom slows, or even contracts, it could affect China’s overall growth rate. As the second largest economy in the world, China is a hugely meaningful component to global GDP. Softening global GDP could threaten stock prices.

Softens China’s Demand for U.S. Treasuries - China sells yuan and buys dollars to control the currency, but they recycle those dollars to buy U.S. Treasuries. Doing so helps the U.S. finance our budget deficits. If the yuan floats, Chinese demand could sap.

Higher Production Costs for Some U.S. Multinationals – as production costs rise, those could get passed along to the consumer. Over time, those multinationals will likely seek cheaper production and move operations (a positive), but in the short term it could affect prices.

The Bottom Line for Investors

Having the yuan float is a tricky issue – both economically and politically – and I’m not sure there’s a perfect solution. Regardless, the bottom line is that any change will happen only gradually, which should give the market plenty of time to digest the economic effect one way or the other. If the announcement comes that China is ready to move the trading band for the currency again, or even ready to let it float, I think there will be some clear winners and losers to emerge and investment implications would likely apply. Until then, it’s a wait-and-see.

___________________________________________________________

Past performance is no guarantee of future results. Inherent in any investment is the potential for loss.

Zacks Investment Management, Inc. is a wholly-owned subsidiary of Zacks Investment Research. Zacks Investment Management is an independent Registered Investment Advisory firm and acts an investment manager for individuals and institutions. Zacks Investment Research is a provider of earnings data and other financial data to institutions and to individuals.