Diving into China?
China reopens, but should investors be piling into its stock markets?
As China, the world’s second-largest economy, reopens its doors following three years of stringent Covid restrictions, investors are pondering its potential in 2023: can the behemoth fire up its economic cylinders quickly, regain its footing, and inject some much-needed growth into a limp global economy?
Its gigantic scale offers tantalising opportunities for businesses and investors alike. Since beginning economic reforms in 1978, China has grown at a lightening clip – at times at double-digit annual percentages. Having begun the millennium representing around 7% of global GDP,1 by 2021, it was 18%.2
It is the largest exporting nation in the world and houses an enormous and growing domestic market, with around 400 million middle-class consumers.3 Its drive to create a more advanced economy rooted in innovation and consumption, has resulted in truly world-class Chinese businesses – an achievement made possible through its increasingly sophisticated capital markets.
For the global investor, it seems evident that Chinese equities are becoming progressively more important in global markets. In addition, they offer genuine diversification benefits away from Western ones.
It raises a question though: as its stock market rattles back into action following the dreary years of Covid, should investors be diving into the deep end and going big on China? In Alliance Trust’s view, nearer term, there are perhaps some reasons to be cautious.
Baby steps, perhaps
1) President Xi consolidates power
Following the Chinese Communist Party’s 20th National Congress last year, President Xi has further centralised his power and sought to surround himself with supporters. While this raises the potential for him to push through unprecedented changes via widespread mobilisation of manpower and resources, it may inhibit progress too – leading China away from the pragmatism that has driven its enormous success, towards an ideologically driven economy that undermines reforms. Important checks and balances may become absent from Xi’s decision-making, resulting in policy missteps, and policy flip-flopping could leave party officials unclear on how to prioritise objectives, as seen with the party’s zero-Covid policy, where they were given the increasingly untenable goal of trying to balance economic growth with pandemic control.
2) Property market still faces challenges
In 2020, Chinese authorities began a two-year crackdown on property developers’ addiction to excessive debt, forcing them to reduce their leverage by restricting their access to capital markets. Many defaulted and homes went unfinished, tying up much urban household wealth. As property accounts for a fifth of China’s GDP,4 alongside China’s zero-Covid policy it was disastrous for economic growth.
In recent months, however, authorities have begun easing financing restrictions and ordering banks to help finance the completion of unfinished homes. This is welcome for the sector, and reviving its fortunes. But given that local authorities rely heavily on land auctions for revenue, they remain incentivised to juice sales, elevating house prices and likely, again, property developer levels of unsustainable debt. In the absence of proper reforms, boom-and-bust cycles in the sector seem destined to continue, risking future economic crises.
3) Geopolitical tensions rise
The war in Ukraine, and tensions between the West and Russia, have spilled over into China’s geopolitical sphere of interest, raising tensions more broadly between the West and East. This, alongside other factors such as retreating multilateralism and the growing influence of Eastern development initiatives, is helping push the world towards a multi-polar future, where economic power is increasingly split between China, the US, and Europe. It raises the likelihood of regionalisation of supply chains and companies, and in an environment where globalisation had benefited China’s economic growth in the past, reduces the strategic attractiveness of Chinese equities.
Alliance Trust's approach
Aware of the enormous potential of China’s economy as it reopens, Alliance Trust’s Stock Pickers have the country on their radar screens. In the near term, while there are macroeconomic and geopolitical risks that need monitoring, the Trust does not take a house view that translates into an allocation to China as a country. Instead, it leaves investment selection to its stock pickers, company by company. Although underweight its benchmark allocation, 1.35% of the portfolio is still invested in Chinese companies, as at 31st Jan 2022.
For the portfolio, Rajiv Jain at GQG Partners has invested in China Construction Bank, China Hongqiao, Industrial & Commercial Bank of China, PetroChina Co, PICC Property and Casualty, Ping An Insurance, and Zijin Mining Group. Bill Kanko and Heather Peirce at Black Creek have invested in Baidu.
Furthermore, it is possible to gain exposure to China’s success without investing directly, as numerous companies around the globe will be linked to its economy. It guzzles vast quantities of energy and commodities such as iron ore, as well as finished products including consumer goods, technology, and manufacturing. In the portfolio, a wide mix of firms has exposure to China, for example, Broadcom, Texas Instruments, Microsoft, Mastercard, Glencore, AstraZeneca, and Yum! Brands.
Marcus De Silva, Freelance Investment Writer
1. https://www.statista.com/statistics/270439/chinas-share-of-global-gross-domestic-product-gdp/
2. WTW, December 2022
3. https://www.ft.com/partnercontent/societe-generale/investing-in-china-short-term-cycles-long-term-potential.html
4. https://www.economist.com/leaders/2023/01/26/chinas-property-slump-is-easing-but-the-relief-will-be-short-lived
This information is for informational purposes only and should not be considered investment advice. Past performance is not a reliable indicator of future returns. The views expressed are the opinion of the Manager and are not intended as a forecast, a guarantee of future results, investment recommendations or an offer to buy or sell any securities. The views expressed were current as at February 2023 and are subject to change. Past performance is not indicative of future results. A company’s fundamentals or earnings growth is no guarantee that its share price will increase. You should not assume that any investment is or will be profitable. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. TWIM is the appointed Alternative Investment Fund Manager of Alliance Trust plc. Alliance Trust plc is a listed UK investment trust and is not authorised and regulated by the Financial Conduct Authority.