China is expanding its armed forces – investors, pay attention

China is dramatically increasing spending on its armed forces. That opens up plenty of opportunities for investors, says Lars Henriksson.

There's a massive Chinese naval base hidden under the island of Hainan, off the coast of Vietnam. It's cut right into the cliff face, just like in a James Bond movie. You can see it here on Google Maps.

The base was completed in 2009, and it reportedly has the capacity for 20 nuclear submarines. At the moment, China only has five type 094 nuclear subs. But as the huge new base shows, that number is probably going to grow.

Advertisement - Article continues below

China is growing more than twice as fast as the US and the EU, and it's already the second-biggest economy in the world. It doesn't yet have the armed forces to match, but that's all starting to change. It increased military spending by 9.9% between 2008 and 2012. And the Institute for Strategic Studies predicts that China will spend more on defence than any other country by 2025.

Sounds scary, right? Well, oddly enough, I think this is good news for investors.

Military spending is huge business

The first is increased private sector involvement. More and more private companies are claiming a piece of China's military spending. Since 2005, the government has actively encouraged private companies to participate in the arms industry.

Second, it means less dependence on unproductive assets in China. China's economy has been heavily based on the housing sector and on infrastructure investment. This has resulted in a misuse of capital. Look no further than the world's largest mall, the new and deserted South China Mall in Guangdong, for example.

Advertisement - Article continues below

Third, military spending boosts innovation & research. Important technology and great companies are often a by-product of military research. Silicon Valley was partly built on military contracts, for example.

Take Fairchild Semiconductor, one of Silicon Valley's first start-ups. The American company has a lot to thank the Cold War for. It developed in the 1960s through military partnerships, building chips for space exploration and missiles for the US. In 1999, the CIA started its own non-profit corporation, In-Q-Tel, which now backs 59 IT companies. One-third of these companies are based in Silicon Valley and focus on areas such as image analysis and data-centre efficiency. If China decides to back military research, the next Silicon Valley could be Chinese. And investors can keep an eye out for the next Fairchild.

Fourth, local development around military bases. When the US built bases around the world, it stimulated local economies and drove asset prices (particularly property) higher. I think the same could happen with China and investors could be part of this chain of interest' in various places in the region.

Investors are starting to take notice of this story. BoA Merrill Lynch identified 17 companies listed on the Shanghai Stock Exchange with over 50% of revenues linked to military use. Since 2000, these companies have outperformed the index by just under 300%, on average. Increased geopolitical tensions were responsible for 200% in the last year alone.

It's hard to ignore returns like that, and China is a lock' to increase its military spending further in the next few years. Let's keep a close eye on this story.




Bullish investors return to emerging markets

The ink had barely dried on the US-China trade deal before the bulls began pouring into emerging markets.
27 Jan 2020
Investment strategy

Beware the hidden risks when investing in emerging markets

Emerging markets look cheap compared with developed countries, but earnings may be less trustworthy.
23 Dec 2019
Emerging markets

Emerging markets: buy when the news is bad

Emerging markets are being squeezed by local turmoil and by more general factors. But bad news can spell opportunity for investors.
5 Nov 2019

Emerging markets bounce back after a miserable few months

Investors in emerging markets have been enjoying some long-awaited relief after a miserable few months.
13 Sep 2019

Most Popular

Investment strategy

How John Maynard Keynes learned the folly of market timing

In an extract from his book The Sceptical Investor, John Stepek explains how the great economist John Maynard Keynes came a cropper when he first star…
25 May 2020
Emerging markets

A new lease of life for the Brics

Emerging markets are having a surprisingly good crisis. Their long-predicted rise will now continue.
24 May 2020

Battling volatility: The benefits of an active manager

SPONSORED CONTENT – Alastair Wilson, managing director of Close Brothers, on the advantages of active investing in times of crisis.
21 May 2020