Mark Williams

China’s 70th anniversary: communism, capitalism and its watershed moment

Mark Williams

Seventy years since the establishment of the People’s Republic of China and four decades after Chairman Mao’s death, China is at a watershed both politically and economically.


Politically, China is now finding its place on a global stage as an equal, rather than adhering to Deng Xiaoping’s dictum to ‘hide your strength, bide your time’. We hear about this shift daily; Donald Trump’s tariffs (and relentless talk of his elusive ‘deal’) dominate headlines currently, but China’s position within the Asian sphere of influence and role in global security concerns also continue to garner attention. Hong Kong’s ongoing protests put more scrutiny on a country adjusting to its new, hopefully more mature, status.


As China evolves politically, we think events will continue to impact investors’ perceptions, but should not be allowed to obscure the extraordinary economic transformation that is also underway. China is trying to progress from its role as a debt-funded, low-end manufacturer to a more service-driven country with slower but more sustainable growth.


These changes should provide many investment opportunities, but there will inevitably also be some significant losers along the way. To find the former while avoiding the latter, it is necessary to understand the internal dynamics of China’s evolving economy.


Those who look only at aggregate trends may fail to understand the more nuanced situation playing out, with the IMF predicting 6.2% growth for China in 2019, the slowest for the
best part of three decades. A cursory assessment might therefore lead you to conclude that – although China’s capital markets are more open and credible than at any time since the Shanghai stockmarket reopened in 1990 – its economic surge is running out of steam, dragging the investment opportunity down with it.


We think this viewpoint is misguided. A
s the Chinese proverb says: “You can’t judge a person by appearance, just as you can’t measure the sea with a pint pot”. China now presents attractive investment opportunities precisely because it is moving away from the inefficient and unsustainable growth-at-any-cost of the past.


China real GDP growth

We both expect and hope that China’s economy slows more in the coming years. Such deceleration is a necessary condition for us to remain positive about the country’s longer-term prospects, which we think remain bright. This is especially striking when contrasted with the gloom that engulfs much of the developed world (where extraordinary monetary policies are failing to maintain growth above 2%).


The reality is that China has grown at levels that are not sustainable. Double-digit GDP growth, often supported by cheap lending to inefficient areas of the economy, is not something that we want to continue. While China’s policies helped it to elevate more people out of extreme poverty than anywhere else in the world (850 million according to the World Bank), this has led to imbalances which now need to be addressed. Encouragingly for investors such as us, the Chinese authorities have shown acceptance of this situation, gradually reducing the annual GDP growth target to 6.5% for the latest five-year economic plan, covering 2016-2020 while prioritising more sustainable growth. This growth, although lower, is
still very high by global standards. China’s position as the regional growth engine remains intact.


China international standards

China’s appeal to us as an investment destination rests on its ability to manage these competing demands of economic reform and economic growth. While slowly improving, overcapacity persists in some 'old economy' capital intensive industries such as steel, cement and industrials. To-date these have often kept alive through relentless refinancing of state-owned bank loans which, one day, will have to be classified as non-performing.


China GDP composition


China also needs to wean itself off export-centric growth. It has made some progress here, reducing exports from 36% of GDP in 2006 to 20% in 2018.


China exports

Although such a transition requires the economy to decelerate, we believe the investment opportunity is expanding for those who are able to differentiate between the companies that will benefit from the economic transition and those that stand to suffer. There should be significant numbers within the former category as a more domestic, services-led economy emerges. Domestic consumption as a whole should grow to account for a rising proportion of demand.


China consumption

As China’s economy moves to a less aggressive growth phase, we also believe that companies will begin to take more considered capital allocation decisions – investing for growth when appropriate while hopefully showing more inclination to return excess cash to shareholders. On aggregate, we expect free cash flow – cash generated by a company’s operations once capital expenditure needs are accounted for – to increase as past years’ heavy investments begin to mature. This will mean more cash is available to be returned to shareholders, which is already providing ample opportunities for income investors given the country’s improving dividend culture.


For many people, the long-term investment opportunities arising from China’s transition will have been soured by Donald Trump’s determination to engage in a destructive Trade War. While this will indeed hamper economic transition, it will not negate it.


We expect there to be increased stimulus from China, and hope that it will remain sensible and targeted at areas which will benefit the economy over the longer term. So far, this has been the case, with sensible infrastructure projects, tax cuts to aid the consumer, and relatively little property stimulus executed. Areas such as these and the accelerated roll-out of 5G plans are giving companies in those areas a significant boost that we think could continue for some time.


While politics will continue to shape some of China’s development, we think the overall ramifications on the region should be manageable. We are finding the number of investment opportunities are rising for discerning investors, and are confident that China’s progress will not be thwarted any time soon.


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Key Risks 

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Investment in Funds managed by the Asia team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The Fund’s expenses are charged to capital. This has the effect of increasing dividends while constraining capital appreciation. 

Disclaimer

The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Monday, October 14, 2019, 3:23 PM