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China: Evolution, Not Revolution

Tuesday, March 20, 2018

Jian Shi Cortesi, portfolio manager for China and Asia equity strategies, takes a look at China’s transition to a consumer-driven economy and its significance for the world’s second-largest economy.

Evolution, not revolution

China’s transition from its ’old’ economy to the new version ─ a consumer-and-innovation-driven model, continues to move at a speedy pace.

To put the scale of change into context, back in 1999, the average annual wage in China was only the equivalent of 1000 US dollars. The economic growth model then was based on low-end manufacturing and large-scale construction, of factories, houses, roads and bridges.

But as the country’s growth model changed and its economic star began to rise, the average annual wage leapt to around 10,000 US dollars. The result was consumer power, which has helped drive the economy in a new direction. Benefiting from government support, consumer spending continues to accelerate. The service industry, which is largely consumer driven, has burgeoned to become the biggest sector and consumption is contributing more than 50% of China’s GDP growth.

Economic growth trends

The question is, will this trend last? We believe the potential is there: industries such as low-end manufacturing and commodities will face a continuous slowdown, but key growth drivers such as consumption, technology, healthcare and financial services look set to expand further over the long term. We take the view that China’s economic transition will continue its current direction and that this will last for many more years.

The picture is not entirely positive, though. Economic growth looks like it may have stopped booming for the moment. In the coming decade, it is anticipated that it is likely to slow from the current 6.5-7% to 4-5%. But we could be in for a surprise, because domestic consumption continues to show strong momentum and synchronised global growth should be positive to Chinese exports. However, we are keeping an eye on the property market as a possible moderator of economic growth.

Chinese equities – the year ahead

Chinese equities had a good year in 2017, so will they continue to return a strong performance in 2018? To put it into perspective, last year’s positive performance was more of a ‘catch-up’ trade following a 70% underperformance against the MSCI World Index in the previous seven years. We believe that they have the potential to keep delivering in 2018, as the positive factors that lifted performance last year are still in place.

It is also useful to bear in mind that global investors have not yet fully explored China’s possibilities: China still remains an underweight in many global portfolios and Chinese equities is one of the least crowded equity markets. This means there is scope for the market to grow further. It is also well worth noting that despite stellar performance, China equity funds did not see much inflow in 2017. We take the view that barring any major negative macro events arising, investors are likely to add money to China in 2018, which will support Chinese stock prices.

Health, wealth and happiness

So, which sectors will be key for investors in 2018? That largely depends on consumer power. Similar to other consumers around the world, the Chinese are spending to achieve their goals of health, wealth and happiness. As a result, the consumer sectors benefiting from China’s economic evolution are top of the list.

Taking the theme of health first, we believe that the health-care sector should experience above-average growth in the long term, and that clean-tech related stocks will be important too, due to Chinese people’s strong desire to have a cleaner environment. In the wealth sector, financial service companies such as insurance businesses trading at moderate valuations are also worth considering.

Consumers’ ongoing pursuit of happiness is evident in the continuous long-term growth in sectors such as e-commerce, mobile entertainment, education and travel. Technology is also still thriving as a sector. In 2010, technology accounted for only around 6% of the MSCI China Index weighting. Back then, the index was dominated by the banking, energy and telecommunications sectors. The picture is now quite different: more than 40% of the MSCI China Index is in the technology sector. But after last year’s strong rally in growth stocks, investors may need to be more selective and stick to those technology stocks with the potential to beat already high expectations.

To sum up, 2018 looks like an encouraging year, even for heavy industries which face a long-term headwind from China’s economic evolution, as the government’s capacity reduction efforts lift the profitability of companies in raw materials and rising oil prices boost the performance of energy companies. However, our preferred focus is on opportunities arising within the consumer and innovation-driven industries. These companies not only have higher long-term growth potential, but also offer more safety as they tend to have low or no debt.


Important legal information
The information in this document is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained in this document may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information. Past performance is no indicator for the current or future development.
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