Geopolitics and economics will be fighting for supremacy in the minds of China’s leaders as they prepare for the 19th party congress this autumn. On the one hand they can bask in the knowledge that within ten years the country is set to overtake the US to become the world’s largest economy. On the other the carefully stage-managed event could be thrown into confusion if an increasingly belligerent North Korea decides to trigger a fresh crisis in its fraught nuclear confrontation with the US.
China’s president, Xi Jinping, is already starting to look like the world’s leading economic player, with his support for globalisation at the World Economic Forum in Davos, Switzerland, this year contrasting starkly with President Trump’s backing of protectionism.
However, while China makes great strides economically, it continues to resist any moves towards significant political reform. It also has to deal with the volatile North Korea on its doorstep. So what does all this mean for those thinking of investing in the Middle Kingdom?
Dale Nicholls, the manager of Fidelity China Special Situations investment trust, says that China still looks attractively valued compared with the developed west. While the US stock market is valued at about 23 times earnings and Europe at about 21, China is much cheaper at 15 times earnings.
Although the Chinese stock market contains a sizeable proportion of state-owned enterprises, many of which don’t deliver great shareholder value, there are a growing number of dynamic private companies that are delivering exciting growth, says Mr Nicholls. “China is ahead of the west for e-commerce penetration. Alibaba, the online shopping giant, is registering annual sales growth of 45 to 49 per cent.”
However, it’s not just in e-commerce that China is an innovator, says Gary Greenberg, head of emerging markets at Hermes, the investment manager. He says that the long-held idea that the term “Made in China” is a synonym for a cheap copies is outdated. “China is ramping up funding for research and its patent awards are outpacing the rest of the world. It graduates far more students in science, technology, engineering and mathematics than the US and is carrying out pioneering work in areas such as particle accelerators, quantum computers and 5G mobile technology.”
China is expected to overtake the US in 2027
Jan Dehn, the head of research at Ashmore, the emerging markets specialist, says that China’s leaders realised years ago that the country’s export-led growth model was unsustainable. The country has embarked on a dramatic transformation of its economy into one focusing on domestic consumer growth. This has required tough reforms, but China is starting to reap the benefits. Mr Dehn says: “China’s savings rate is likely to decline from 49 per cent today to close to single digits by the middle of the century. This means that it will experience the largest consumption boom the world has seen as consumption rises faster than GDP.”
He forecasts that, having overtaken the US economy in about 2027, China’s economy will be 2.4 times larger than the US economy by 2050, or 4.1 times when adjusted for purchasing power.
He adds: “While China has embarked on a policy of reform and embraces globalisation, the US under Trump is retreating into protectionism. China is going to win and is inviting the rest of the world to ride along.”
Mr Nicholls says that China’s debt mountain remains a big problem, having grown from 140 per cent of GDP in 2008 to 300 per cent today. The unwinding of this debt will be a painful process and a slow one, because most of the money has been lent by state banks to state enterprises, and the state does not want to cause bankruptcies on a massive scale that would throw millions of people out of work.
Mr Wang agrees that a debt crisis remains a concern, but argues that the government has started to take steps by cracking down on shadow banking (bank loans in disguise).
While North Korea bares its teeth, it is unlikely to bite one of the few hands to feed it
He adds: “Other risks include potential trade disputes with the US, concerns about corporate governance and the danger of excessive government intervention.”
A further potential headwind for China is the prospect of a rise in US interest rates, warns Josh Crabb, the head of Asian equities at Old Mutual Global Investors. A rise in US rates tends to strengthen the US dollar, increasing the debt burden on many Asian companies that borrow in the currency.
Geopolitical risk has not gone away either, argues Julian Mayo, an investment strategist at Charlemagne Capital, the fund manager.
He says: “North Korea is once again raising the temperature in the region with its recent missile launches. However, this is largely irrelevant as far as the Chinese economy is concerned, because trade between the two countries is small and getting smaller given the sanctions. While North Korea continues to bare its teeth, it is unlikely to bite one of the few hands that feeds it, even if it is on increasingly meagre rations.”
One long-term cloud of uncertainty that hangs over China is whether, as the Chinese population grows wealthier and better educated, it will start to challenge the one-party rule of the Chinese Communist Party and press for greater democracy.
The resulting clash could trigger a massive upheaval that would, at least in the short term, damage the Chinese economy and give investors a scare. However, this remains a distant problem, says Mr Greenberg. “China’s political structure isn’t going to change any time soon.”
● Howard Wang, the manager of the JP Morgan Chinese investment trust, thinks that the decision by MSCI, the stock index providers, to include domestically traded China A-shares in its influential emerging markets index from next year will give a huge boost to homegrown Chinese stocks because index funds focusing on the region will be obliged to buy them.
● Dale Nicholls, the manager of Fidelity China Special Situations investment trust, says China’s technological advances make it the place to invest: “China is going cashless at a very rapid rate and is a world leader in the mobile payments market. Didi Chuxing, the Uber of China, is clocking up 19 million taxi rides a day, while Mobike, which is a bike-sharing company that operates via an app, is also hugely popular.”
● Simon Elliott of Winterflood Securities, the stockbroker, says the Fidelity China Special Situations and JP Morgan Chinese investment trusts are a good way in to the market. He says: “The Fidelity fund’s performance has been very strong. The portfolio contains small and medium-sized companies and looks to benefit from the growth of the middle class and the rise in consumption. The JP Morgan trust invests in China, Taiwan and Hong Kong. The managers have moved the fund more towards ‘new China’ stocks, with more emphasis on services rather than manufacturing.”
● Philippa Gee of Philippa Gee Wealth Management also likes Fidelity China Special Situations, as well as the Invesco Perpetual Global Smaller Companiesfund. She says that the Fidelity investment trust is trading at a discount to its real, or net asset, value, and that after an early wobble, performance has been strong. She says that the Invesco Perpetual fund offers a wider spread of investments, but has several holdings in the region, including in Taiwan and Hong Kong.