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 (September 2022)
In the middle of the year, the global economy slowed down significantly, as inflation stayed high and central banks hiked rates further. As a result, investors worry about a coming recession.
In China, the themes are the opposite: the economy re-accelerated in the middle of the year after a low point in April, inflation is low, and monetary and fiscal policy is being eased. The question now for investors is exactly how much speed can it continue to pick up in the third and fourth quarter?
The good news in China is that “Zero COVID” is no longer paralyzing the economy, exports remain strong, and fiscal easing is leading to higher infrastructure investment. The bad news is that the “zero COVID” policy and recent regulations continue impacting the economy by keeping confidence low for households and businesses.
While individuals can now move around and spend more easily, consumers remain worried about their future income prospects and have been unwilling to increase spending much. In addition, small and medium sized business continue worrying about future lockdowns impacting their business, keeping hiring muted and investment low.
Lastly, recent reforms of the housing sector continue to heavily weigh on the sector, with home sales contracting steeply.
As a result, China is likely to continue stepping on the monetary and fiscal easing pedal. During August, China cut interest rates and increased its local government fiscal spending, which should help growth in 3Q. However, questions remain about the 4th quarter if improvements to confidence don’t occur.
As a result, investors will be watching measures that could help confidence, such as: 1) a big fiscal relief package for housing developers, and 2) a bigger change to the zero COVID policy, perhaps after the National People’s Congress meeting on October 16th.
For investors looking forward, the outlook is brighter for Chinese assets, as the economic momentum shifts from West to East and as low valuations already reflect a lot of risks for China’s economy and markets.
However, the recovery from the March lows won’t be a straight line, with volatility picking up from time to time.
Investors should remain focused on the long-term opportunity for Chinese markets – and should make sure they are asking themselves not whether they should invest in China, but HOW they are invested in China. It is key to focus on areas of policy support: local markets (A-shares, local currency bonds), and themes like domestic consumption, business tech innovation, and the energy transition. Most of all, active management and a long time horizon is key for reaping the rewards of investing in China, while navigating the risks.
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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