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Don’t overlook China

Tom Stevenson

Tom Stevenson - Investment Director

This article first appeared in the Telegraph

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Quick-witted, resourceful, versatile, kind. These are the characteristics of the Rat, whose year begins on Saturday in China. Faced with a hostile trading partner across the Pacific and unrest on both flanks at home, Beijing is going to need all of those characteristics and more in the year ahead.

Investors, too, will be hoping for a change in the market mood in Shanghai and Shenzhen, where China’s principal stock exchanges are located. The past ten years have not been kind to anyone fooled into thinking that significantly higher economic growth in China than in the developed world would naturally translate into stock market outperformance.

Over the past ten years, the S&P 500 index in New York has almost trebled. The equivalent index in China, the CSI300, has added just 20% over the same period.

China has been in the headlines in the past week for a couple of reasons. Neither provided much cheer for long-suffering investors in the world’s second largest economy.

The first bit of news, the signing of a phase one trade deal with the US, is on the face of it good news. After two years of tariff tit for tat, Beijing and Washington came together to agree at least a truce. The reality, however, is that the terms of the deal change little. Donald Trump has achieved almost none of the wins he set out to achieve in 2018. But China has little reason to celebrate either. Although new tariffs have been postponed, existing ones remain in place. The prospect of a meaningful phase two deal is remote, with the US President otherwise engaged for the rest of 2020.

The second set of headlines, around economic growth, are unequivocally disappointing. Last Friday’s GDP figures showed the Chinese economy growing at its slowest rate since 1990. The data confirmed an economy under pressure, with unemployment rising, weak consumer confidence, a falling birth rate and pressures from rising debts and an unstable property market.

The data highlighted a couple of areas of concern. Manufacturing investment growth fell to a record low on the back of the trade war, while disposable income in cities (a key driver of the Chinese growth story) is flagging.

Against such an unhelpful backdrop, it’s perhaps unsurprising that investors have had a tough time of it too. The Chinese benchmark is pretty much where it was back at the beginning of 2018, a year that investors were glad to put behind them. Shares ended 2018 30% lower than they started. Last year was significantly better as falling interest rates, at home and abroad, stabilised growth and the trade picture improved as the year progressed. But it needed to be - 2019 did no more than recoup the prior year’s losses.

For contrarian investors this is the perfect set up. A market that no-one likes, which has underperformed significantly for years and which nonetheless has a positive long-term story to tell. So, what is the case for China?

The first point is that China is far too big for investors to ignore. Around a fifth of the world’s population live in China, it’s a $12trn economy, second only to America’s, and in the past three years it accounted for about a third of global growth. That was roughly twice the US’s contribution.

The country’s financial markets, while immature, are also too big to sensibly leave out of a global allocation. The markets in Shanghai and Shenzhen host the shares of around 3,500 companies with an aggregate value of $8trn. China long ago overtook the Japanese market’s $5.6trn, across 2,000 companies. And that doesn’t count the Chinese companies that have chosen to list in other markets around the world such as London and New York.

If China’s shares were given their full weighting in MSCI’s stock market indices, they would account for more than 40% of the emerging markets benchmark. China represents 55% of the Asian markets, excluding Japan.

Although the overall growth figure for China is slowing, it is still at a level that developed markets such as our own can only envy. The latest 6.1% growth figure compares with our own growth of just 0.9% year on year. Within the Chinese economy, too, there is significant variation in growth rates, providing a wealth of opportunities for stock-pickers on the ground.

China has long sought to rebalance its economy away from investment and exports to domestic consumption and this remains a long-term secular growth story. Even within this general consumption narrative, there are some interesting areas to explore. For example, while it is tempting to think that China’s consumers would want to mimic their counterparts in the west, local brands are seeing faster growth. The regionalisation of the global economy accentuated by Trumpian nationalism will only accelerate this trend.

So-called premiumisation is another key driver of investment ideas in China as more affluent consumers seek to signal their increasing wealth and sophistication. A move towards services and experiences, such as education and travel, provides yet another fruitful area for investors. The comparative lack of research into Chinese companies means that investors with analysts on the ground can achieve an edge that is much harder to find in mature markets like the US and Europe.

China remains a volatile market. The past two years have illustrated that clearly. There is a continuing question mark over corporate governance, although it is improving. High debts and a fragile property market will always weigh on valuations. And foreign investors do not have full access to all the opportunities in the country.

That means Chinese shares should only be a part of an investor’s portfolio. It is not unreasonable to still treat China as just one element in an investor’s overall emerging market exposure. But it would be as odd over the next ten years to ignore China as it would have been foolish to ignore the US over the past decade. This is the year to trap the rat.

Important information: The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

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