Investors must closely monitor government policy in China to identify the growth industries of tomorrow
Scholars of Chinese history are aware that natural calamities, supposedly triggered by the “sky god”, can call into question the legitimacy of the country’s earthly rulers. Recent meteorological mayhem wreaked by Typhoon Doksuri has left more than 20 residents confirmed dead and almost a million evacuated, yet few are challenging the supremacy of President Xi Jinping.
“These sorts of things are always short term, unless there is any sign of a challenge to the ‘Mandate of Heaven’,” comments Alice Wang, Chinese fund manager at specialist investment boutique Quaero Capital.
Commentators note that the still widely-held belief, dating back to the 11th century Zhou dynasty – preferring moral leaders over despotic pretenders to the celestially-blessed throne – has even overcome the natural challenges of swine flu and Covid.
“We are more concerned today about power supply as China continues to electrify and modernise,” says Ms Wang, relating the population’s increasing engagement with economic realities of geopolitics, deflation and energy security. “Renewables are both a heavier consumer of power and more heavily influenced by the volatility of weather patterns.”
Key to future Chinese policy will be the impact of fast-changing power prices, including fossil fuels increasingly imported from Russia, and the rising influence of renewables in the local and global energy ecosystems.
Rather than indulge “wishful thinking” of economists awaiting China’s descent into a Japan-style inflationary spiral, Ms Wang believes investors should keep a keen eye on the vibrant electric vehicles (EV) space.
“One thing to keep in mind is that Chinese scale and moving up the value chain will continue to be a structural driver of global deflation,” says Ms Wang. “Look at the cost and dominance of Chinese EVs, having propelled China to becoming the largest auto exporter in the world, and their share gain across shipbuilding, from less than 10 to 48 per cent of global shipyard output in 20 years.”
The fast-changing dynamics of a “stockpicking environment” rely on monitoring Beijing’s industrial policy, believes Ms Wang. “Probably some of the biggest upside lies in policy changes for particular sectors. For example, if stronger property support comes through or education companies are allowed to operate again,” she says, commenting on well-documented government clampdowns on education and technology stocks.
“Internet companies have all had fairly good earnings this year but have been punished by foreign positioning, so that is one regret we have,” says Ms Wang.
Common prosperity bites back
These political considerations can ultimately determine the success or failure of the ‘Chinese Model’. Difficulties in filling manual and call centre jobs could even bode well for sectors which fell foul of the “common prosperity” policy, aimed at boosting social cohesion, sometimes at the expense of economic growth.
“This makes me optimistic that the government might reverse some of the policies on internet platforms and education,” says Ms Wang. “These sectors have historically produced more of the kinds of jobs acceptable to the privileged youth.”
A government which previously dented investor confidence by forcing leadership changes at leading technology firms Tencent and Alibaba learned its lesson when it curbed “endless lockdowns” and began to stimulate the economy, say market commentators.
Most Chinese citizens have bought into the “common prosperity” policy, which is “trying to rectify the demographic challenges of China”, reports Chetan Sehgal, lead portfolio manager at the Templeton Emerging Markets Investment Trust.
“Now the question is whether capital should be allowed to dominate industries. The premier has gone to meet technology companies…and they don't want their most talented individuals or youth to feel dejected about working in those kinds of companies,” he says, with impetus for the tech sector now emerging from both the state and new platform competitors.
Asset and wealth managers perceive a sea-change occurring in how the government is interacting with industries, technology in particular. Despite a sharper than expected 14.5 per cent slump in exports during July, the changed tone of announcements at the recent politburo meeting suggests policy-makers are acknowledging they must respond to economic weaknesses, including a vulnerable real estate sector and sluggish domestic demand.
“Currently, the stimulus package is mainly aimed at increasing domestic demand,” says David Perrett, co-head of Asia-Pacific equities at M&G Investments, reflecting the cautious optimism of investment firms. “The automotive sector is being strengthened and, in addition, there are tax breaks and subsidies for modernisation and purchase of housing. These measures have kickstarted a reset of sorts.”
As well as promotion of home improvements, restrictions on the ownership of used cars is being lifted and incentives for introduction of electric cars improved.
“All this should start to have an impact on the real economy, especially if incentives are well implemented at local level,” says Mr Perrett, with further stimulus announcements expected during coming months, although other investors point to lack of clarity around these measures. “The current starting point for Chinese equity valuations is largely at very attractive levels," concludes Mr Perrett.
Increasing Chinese weighting, particularly in electrification themes, has been a key feature of emerging market portfolio managers. “We call this ‘electrification of everything’, particularly firms supplying materials for electric vehicle batteries,” says Templeton’s Mr Sehgal. “We have also bought companies which sell power tools based on battery technology rather than fossil fuels,” reflecting a fast-decarbonising world.
Geopolitical challenges
But the biggest challenge for Chinese companies is a geopolitical one. In addition to rising housing and education costs, geopolitical tensions are becoming regular topics of conversation among factory floor employees, says Mr Sehgal, with people wondering out aloud whether the Chinese economic system can effectively survive outside the broader global trading system.
“Right now, the fear factor for them really is this geopolitical isolation,” he says. “I think that that is one of the reasons why confidence has not come back to the same extent as it has in many other markets, post Covid.”
This uncertainty can however be turned on its head to benefit Chinese companies looking for foreign custom, with a political hierarchy of markets shaping the export economy. Europe, particularly Germany, and Asia, he says, are taking over from the US as key export markets for fast-developing Chinese technology, particularly relating to vehicle manufacture.
“It’s going to be difficult for Chinese companies, which maybe are at a disadvantage in the US,” he says. “They would like to be in the US, but they think it's difficult. In Europe, they think they can be competitive. And in south-east Asia, they think they can be dominant. That's how they look at it.”
This calculation sees Chinese companies increasingly investing in markets such as Malaysia, with Chinese factories starting up next door to US competitors. “A lot of south-east Asia will benefit from that trend of both China as well as the US investing in their region,” says Mr Sehgal.
“By and large, the Chinese want to work with the rest of the world. And even if they think the US is more difficult, they still want to align themselves with Europe in some way,” he says. “If these geopolitics are sorted, Chinese markets will trade at a much higher level.”
The head of a wealth management firm serving family offices says it is in the interest of President Xi to be “pro market” and more open to global trade in order to return to normality. “This is not because he wants to be nice to the West, but because he needs to boost his economy.” For today’s commentators, it seems geopolitical realities are eclipsing faith in divine intervention.
