Investors have been focused on two major events as of late, namely, the second wave of the coronavirus pandemic spreading throughout Europe, and a major election to determine the fate of the US, the world’s largest economy.
However, Erik Lueth, global emerging market economist at Legal & General Investment Management (LGIM), believes investors should not overlook developments in the world’s second-largest economy, China.
Investors have favoured Chinese equity strategies this year with retail inflows to the
Indeed, it has been one of the best-performing major economy year-to-date, with the MSCI China index outperforming the FTSE All Share by almost 45 per cent and the S&P 500, by over 15 per cent.
Performance of major world indices YTD
Source: FE Analytics
Given this performance, the economist emphasised China’s critical importance to the outlook for markets and the global economy, highlighting seven key things to consider when investing in the region.
The first thing he highlighted was China’s coronavirus response. After contracting by 10 per cent in the first quarter, China’s economy has managed to return to the pre-virus output path.
He forecasted growth for the whole year amounting to 2 per cent, making China one of the few economies to expand this year.
He said: “The relatively fast recovery from the virus is attributable to an ‘eradication’ strategy as opposed to the west’s ‘suppression’ strategy.
“When China lifted its lockdown, daily infections were in double digits. By contrast, when Germany lifted lockdown measures, daily infections were around 650.”
Leuth also highlighted China’s policy response, which he said was ‘relatively muted’ compared with other countries. China’s fiscal stimulus amounted to 4 per cent of GDP, compared to 12 per cent in the US and a world average of 8 per cent.
He said: “Credit growth – the key metric to gauge the monetary stance – has been even slower, accelerating by two percentage points, a far cry from the 15 percentage points after the Lehman crisis.”
The third thing he highlighted was China’s growth outlook.
He said: “We expect China’s economy to keep slowing very gradually over the next five years – possibly to 5 per cent by 2025.”
The economist attributed his forecast to a significant credit overhang, an ageing population and the plateauing of Chinese global market share.
“That said, we remain confident about China’s long-term growth prospects: the key to development is industrialisation, a process that China has figured out, in our view,” he added.
The next thing LGIM’s Leuth pointed to was China’s debt build-up, which since the financial crisis, has been ‘unprecedented’ for any large economy.
However, he doesn’t see this as a harbinger of a financial crisis like many other investment professionals.
“China’s debt is not owed to foreigners. Instead, most debt is owed by state-owned enterprises [SOEs] to state-owned banks, in effect shifting money from one pocket to another,” he explained.
“Coronavirus presented a stress-test of epic proportions which China, despite all of its debt, passed with flying colours.”
The fifth thing Leuth (pictured) highlighted were the misconceptions about China, which he described as “a developed-market perspective that is overly concerned with efficiency”. 
He argued that at China’s level of development, learning how to master cutting-edge technologies is “more important than efficiency”.
He said: “To give an example, many investment professionals are concerned about loss-making SOEs.
“But, if you want to learn how to produce world-beating trains, you need to be prepared to make losses. It is this long-termism that we believe is behind China’s success.”
The sixth thing that Leuth pointed out was China’s role in the world economy: “China now accounts for 16 per cent of world output in US dollar terms and for one-third of world growth.”
Whilst the country may seem dependent on exports, the economist highlighted that its export market share stabilised at roughly 13 per cent in 2013.
He said: “Since then, with China experiencing slower growth and being more circumspect of large stimulus, the commodity supercycle ended. This hurt emerging markets.
“The relocation of industry out of China as a result of the trade war has not been pronounced so far, in our view due to the lack of alternatives and the pull of its internal market.”
The final and most important thing Leath said investors needed to consider was China’s geopolitics.
“Under president Xi Jinping, we believe China has moved further away from western political thought as evidenced by greater surveillance, the weakening of the rule of law, and the embrace of lifelong leadership,” he said. “This has contributed to the reassessment of China as a rival in the US and Europe.
“China’s foreign policy has also become more muscular, even if its ambitions haven’t generally extended beyond its immediate neighbourhood so far.”
This is why he believes that a clash with the US in the not too distant future looks to “increasingly likely”.
All things considered, LGIM’s Leuth believes China will continue to play a major role for investors going forward due to two reasons.
Firstly, he believes the most important theme in geopolitics will be the emerging rivalry between China and the US.
He said: “It will shape the world like the Cold War did in the 1960s and 1970s and, in our view, will cause moments of volatility for investors.”
The second reason is down to China’s economic growth trajectory, which he said was “crucial for the economic well-being of the world”.
Indeed, Chinese growth has contributed around one-third to global growth over the past 10 years, according to the economist.
“In this respect, we believe the world – and especially emerging markets and commodity markets – will benefit from Chinese economic might,” he finished.