A relaxed read on the issues of the day
Looking at China’s growth over the last 60 years, the nation’s nominal GDP has grown a staggering 37 times, surpassing Asian counterparts such as India and all European economies in the process. Leveraging the growth of its working age individuals and a population of 1.4bn citizens has allowed China to grow manufacturing output and in recent years has created a middle-income economy and domestic spending, increasing China’s economic independence from the west. The result is a $17.4tn economy and the largest trading partner for many developing nations. Its economy grew 8.1% in 2021 but expectations for 2022 are set lower with economists suggesting growth for this year to be around 4-5%. Many expect Beijing to target a growth rate of 5%.
Reminiscing over 2021 highlights a stark contrast between developed (western) markets and developing (China & emerging) markets. The S&P 500 and Nasdaq gained 27% and 21% respectively. However, across the Pacific there has been a different narrative with the Chinese blue-chip CSI300 index finishing the year 5% lower and the Shanghai Composite index up a mere 5%, having been impacted by government intervention, supply bottlenecks and a zero-tolerance to covid policy causing rapid shutdowns. Nevertheless, we could find that the China story is set for yet another twist with support for a bullish Asian market throughout 2022.
For those who are enthusiastic allocators to China, the investment thesis is supported by how China is addressing concerns surrounding its troubled real estate sector and the managing the balance between export and domestic growth to drive sustained growth over the long term. Financing costs are coming down: the interest rate on medium term loans worth 700bn yuan (£80.6bn; $110bn) is being cut to 2.85% and an additional 200bn yuan is being pumped into the financial system, which should support stock markets. This also supports the People’s Bank of China (PBOC) desire for large private and state-owned companies to acquire real estate projects from developers who are struggling, reducing the risk of mounting debts destabilising the economy. This extends to Chinese banks, which are being encouraged to provide lending to financially stable developers, to fund the acquisition of projects from developers who are cash-strapped. Overall, the risk of default should be reduced.
As its economy matures, China is aiming to rebalance its sources of growth with a growing reliance on domestic consumption, rather than exports. Forecasts suggest that private consumption is set to double to $12,000 per person by 2030. Supporting this are government pledges to increase household income, grow urban areas and shift away from the imports of Chinese goods by developed nation economies. This should directly benefit Chinese domestic companies.
Risks still loom in China, with its zero-tolerance to covid policy resulting in whole towns and cities being closed when cases are discovered. This could curb both factory output and domestic consumer spending, which would dent Q1 and Q2 economic performance. Despite the government’s best efforts to reduce the risk, real-estate poses a threat to economic stability and there is a material, if decreasing risk, surrounding the sector. Recently Shimao, a property developer, missed a $101m repayment, despite being considered a ‘relatively healthy’ name. According to Nomura, Chinese developers face $20 billion in maturing offshore US$ denominated bonds in Q1 of 2022 – double that in Q4 of last year – and a further $19 billion in Q2. This unfortunately suggests there may be further scope for significant defaults to offshore lenders.
In comparison to last year, China appears a more attractive opportunity for a variety of reasons. Firstly, policy risk seems to have abated somewhat, with political factors likely to favour stability in 2022. In order to meet its goals for economic development and prosperity, China will need to encourage a growing and healthy private sector, therefore despite sentiment being negative in 2021, there scope for positivity. Investors may also feel more confident that many Chinese companies are now on attractive valuations after the sell-offs of 2021. The MCSI China Index is trading on a 12-month forward P/E ratio that is discounted 45% to that of the S&P 500 and corporate earnings are expected to grow at 15%. As the US is only expected to see growth of 9% this may provide additional conviction.
China is making conscious effort to mitigate the risks, by loosening the requirements for mortgages to improve private home ownership and move properties out of developers’ portfolios. There are clear tailwinds that support China’s focus on innovation and growing household income with the Common Prosperity Plan. This includes increased spending to roll out 5G and testing of 6G, and more general technology related R&D within data access and security. The focus on growth and innovation, combined with a loose monetary policy should mitigate the current issues China faces and lay a runway to steady growth into the future.