A Guide to China
Outlook for the world's second largest economy
Check out the main trends for the world's second largest economy - China - and what opportunities there are for your investments. Based on information from Guide to China, our Global Market Strategist, Gabriela Santos, presents her vision of the economy and main markets.
Guide to China
Gabriela Santos (00:06)
In 2010 China surpassed Japan to become the second largest economy in the world. As we show in our Guide to China, page four, we estimate China will surpass the US to become the largest economy in the world in 2027.
Gabriela Santos (00:23)
This is a couple of years before we had estimated pre-pandemic that's because China had the only successful V-shaped recovery in the world in 2020, while the US had a more V-interrupted growth pattern.
Gabriela Santos (00:37)
What's more exciting, is China is probably going to double its GDP per capita over the next decade, as we also show on Guide to China, page four on the right. That means China's going to move from being a middle-income country with a GDP per capita of about $10,000, similar to Brazil, to being a high-income country with a GDP per capita of about $20,000.
Gabriela Santos (01:04)
Now, this is a journey that very few emerging markets do successfully, and China has a plan to do so. They really plan on changing the growth drivers of their economy. From exports to domestic demand, from investment to consumption, from manufacturing to services, from low value add to high value tech innovation.
Gabriela Santos (01:31)
Now, if China is successful in this journey, which we believe they will be, then China will double the number of people in its middle-class. As we show in Guide to China, page five, that means that nearly half a billion Chinese will enter the middle class over the next decade. Imagine the growth in their discretionary spending in things like autos and cell phones and financial services and education and healthcare. And most of this done digitally.
Gabriela Santos (02:03)
The most interesting aspect for investors is that China has been opening up its capital markets for foreign investors. Investors can now access the second largest equity market in the world, as we show on Guide to China, page 33. China offers higher return potential than what we estimate for developed markets. That comes from higher revenue growth, especially from sectors like consumer discretionary, technology and healthcare.
Gabriela Santos (02:34)
Investors can also access the second largest fixed income markets in the world, as we show in Guide to China, page 46. China offers higher yields than those available in similarly rated investment grade peers and for both markets, because they're still very dominated by domestic investors, they have a very low correlation to other markets around the world.
Gabriela Santos (02:58)
Now there are many benefits to Chinese markets, but there are also risks. So it's really crucial for investors to use active management, to avoid the pitfalls and even take advantage of some of the volatility and market inefficiencies that come up along the way.
Gabriela Santos (03:15)
So the China growth story is far from over. China's big, but it's getting bigger. It's also a lot more accessible for foreign investors, and it has a key role to play in global portfolios in return, income and diversification. So China really is too big and too important for investors to ignore.
A summary of the latest trends for China (May 2023)
A major positive change to this year’s global economic outlook was China’s pro-growth policy pendulum shift late last year. Back in December, economists expected China to grow only 4.8% this year. Fast forward to today – expectations now stand at 5.5%. This growth upgrade has lifted indirect beneficiaries of China’s recovery, such as European luxury companies (with some names up over 50% since 3Q and continuing to hit all-time highs this year). However, MSCI China is now down 0.8% year-to-date, a sizable underperformance of 970bps versus global equities. When will Chinese markets react to China’s improved economic prospects?
Back in February, we argued that China was unavoidable for investors this year due to the arrival of the COVID reopening boom, the unleashing of three years of pent-up demand of 15% of the world’s population, and China’s policy pendulum shift towards the pro-growth side (easing pressures on the real estate sector and boosting private business confidence). Since then, China’s economic data has broadly surprised to the upside, especially household services consumption (food services sales surged 26% year-over-year in March) and the housing sector (contraction eased to 5.8% year-over-year in 1Q versus -10.0% in December). Chinese policymakers’ official 2023 GDP goal of “around 5%” is now seen as a floor rather than a ceiling.
However, Chinese equities have not responded as strongly as the economic data alone would suggest. After an initial rally of 60% from late October to late January, Chinese equities have corrected 15% and are now down marginally for the year. The initial rally had brought valuations back to average levels - and investors are now asking for a buffer to compensate for the question marks around how long the economic recovery will last (in addition to ongoing geopolitical tensions).
For investor confidence to pick up, three other confidence turnarounds need to take shape:
1. Improvement in private business confidence: While 1Q GDP was strong, a notable area of sluggishness was private investment which grew only 0.6% year-over-year (versus 10.0% in the public sector). Action by policymakers to reassure the market of its stance in supporting the development of the private sector would be key.
2. Further recovery in consumer confidence: Consumer confidence has started to recover this year, but income expectations and willingness to consume remain below average, raising questions about how much consumption will broaden beyond restaurants and domestic travel. An improvement in the labor market, spurred by an improvement in business confidence, would be key.
3. Upgrade to corporate earnings expectations: While the economic data has surprised positively, Chinese earnings estimates have moved up only 2%pts this year. Strong 1Q earnings results, combined with upgraded guidance from management, would be a welcomed confirmation of economic trends and provide a lift to full year earnings estimates.
While it may take some time, we do expect confidence to improve – or for policymakers to stimulate the economy further if it does not. The key for investing in China is to do so thoughtfully, based on “waves of reopening” (services then discretionary goods) and “beyond reopening” themes (green economy and advanced manufacturing sectors).
The right way to invest in China
- Invest alongside areas where there is policy support: domestic consumption, hard technology, energy transition
- Think as long-term as policy makers, because these periods of short-term high volatility are normal in Chinese markets
- Focus on local markets: A-shares for equities and local currency government bonds
- Take advantage of moments of crisis when stocks and bonds of good quality companies are sold off alongside other ones, creating better valuation opportunities
- Invest actively with a manager that can do careful security selection in order to pick which companies will survive and which ones will thrive in China’s new phase of growth.
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