NEW YORK (Reuters) - China's 1.3 billion consumers may be the only thing preventing the world's second-largest economy from a hard landing that could reverberate across global markets, according to a report issued by asset manager BlackRock Inc (BLK.N) on Tuesday.
The Chinese economy is transitioning from production and exports to building a strong middle class that could support future growth. That shift is likely to end the country's run of double-digit economic gains, leading to further volatility in global stock markets, BlackRock managers said.
"Most economies slow when they move from production to consumption," said Ewen Cameron Watt, chief investment strategist at the BlackRock Investment Institute.
Investors who continue to bet on hard commodities and infrastructure could be especially burned by the shift, Watt said. Basic materials companies will likely suffer as China slows its commodity consumption, leading to drops in pr o fits and share prices for Australian, Canadian and British companies that have supplied much of China's raw materials.
China faces other issues, too. Property values are widely considered to be inflated, bank regulations meant to curb excessive lending are loosely enforced and seven of the nine members of the elite Politburo Standing Committee, often seen as the power brokers of the national government, will be replaced in the fall.
That might seem to leave little to invest in. But BlackRock and others are targeting the millions of Chinese consumers who can purchase basic goods -- refrigerators and ovens -- for the first time. That means putting money into companies such as China Mobile Ltd (0941.HK) and Shanghai Industrial Holdings Ltd (0363.HK) that provide basics such as cell phone service, tobacco and paper and packaging materials.
It is a strategy that is becoming popular with fund managers and analysts. Edmund Harriss, manager of the $171 million Guinness Atkinson China and Hong Kong fund (ICHKX.O), has been moving his portfolio deeper into Chinese companies that provide consumer goods. Paul Dietrich, head of global research at Middleburg, Virgina-based Washington Wealth Management, says China's consumers "are the next big growth area."
"Over the next decade, it's the boring, Warren Buffett-type companies that are going to do exceedingly well," he said.
In large part, that is a reflection of demographic change. Economists at Deutsche Bank estimate that, by 2015, about half of China's households will have an income whose purchasing power is equivalent to someone living in Mississippi - about $29,000. In 2010, only about 15 percent of Chinese households boasted the same level of income.
Jeff Shen, who heads BlackRock's emerging market equity group, said investors should look to multinational companies that make consumer goods. Luxury goods, in particular, are expected to continue to perform well.
Tiffany and Co (TIF.N), for example, is expected to make 18 percent of its global sales from China, while Coach (COH.N) and Burberry (BRBY.L) are expected to see between 6 and 10 percent of total sales come from the country. Burberry Group Plc (BRBY.L)and Coach Inc (COH.N) have performed particularly well already in 2012. The shares of each company are up more than 20 percent.
Investors could also benefit by targeting domestic Chinese companies, Shen said. In the fund he manages, the $85 million BlackRock Emerging Market Long/Short Fund (BLSAX.O), Shen owns China Mobile and is shorting export-focused companies such as China Shipping Container Lines Co Ltd (601866.SS)
"Valuations have come down quite a lot over the 18 months and look a lot more attractive today," he said.
It is generally easier for a U.S.-based investor to hold Chinese stocks through an ETF or fund. The $905 million SPDR S&P China ETF (GXC.P), for instance, holds Chinese companies that are listed in Hong Kong or New York.
The fund, which Morningstar named as its pick for broad exposure to the Chinese stock market, holds 165 long positions in stocks. It costs 59 cents per $100 invested and yields 1.9 percent. China Mobile (0941.HK), China Construction Bank Corp (601939.SS) and Internet search company Baidu Inc (BIDU.O) are its top holdings, with about 20 percent of assets.
BlackRock reported first-quarter earnings on Wednesday. Excluding the costs of some compensation plans and some other expenses, the firm earned $3.16 per share. On that basis, analysts on average had expected $3.04, according to Thomson Reuters I/B/E/S. The company said its profits were bolstered by strong inflows into its popular iShares ETF business.
Editing by Jennifer Merritt and Andre Grenon