In recent months, some international investors have been taken by surprise by developments in China and begun questioning whether the market remains investable.
Valuations on equities have fallen, in response to regulatory changes affecting Chinese companies and the recent failure to repay two bond obligations to overseas investors by Chinese property developer Evergrande.
In combination, these events will likely weigh on sentiment and cause China’s economy to decelerate quickly.
While it is easy to focus on these immediate headwinds, one of the advantages of investing in China is the ability of the state to respond quickly to emerging challenges.
As a result, the government is likely to introduce more supportive economic policies soon and put China in a stronger position to manage any turmoil over the coming months.
With that in mind, where should investors look for opportunities? Consumer consumption is a robust source of growth, particularly as the Chinese middle class expands.
By 2030, China and India together will represent 66% of the global middle class: with more than 70% of China’s population likely to become middle class.
Over the past 30 years, European luxury goods companies, such as LVMH, Ferrari, Moncler and Pernod Ricard, have positioned themselves to benefit from this growth. They will continue to benefit, as growth in demand for luxury goods is predominantly being driven by the middle class.
Exposure of European company revenues
Source: Redburn, June 2021
Regulation can be good
Recent regulatory changes brought in by the Chinese government have been decried by some, but are positive for the long-term health of the domestic economy. Reforms aim to boost employee conditions, improve outcomes for consumers and clamp down on monopolies.
Multinational technology companies like Alibaba and Tencent have consequently become bottom-fishing opportunities due to the impact of new regulations on their valuations.
The most exciting opportunities, however, lie in mid-cap ‘rising star’ companies that will benefit from anti-monopoly regulations, which will create a more level playing field for these emerging companies.
A key aim of the new Chinese Five-Year Plan is to create a more level playing field for companies and recent reforms are an attempt to realise this goal.
Private companies in China create 90% of new jobs and will be key to winning the state’s technology battle with the US – which it is determined to succeed in. It is therefore reasonable to expect the Chinese government will remain supportive to private sector development.
Cleaner China
Clean energy is another area profiting from government support. China is under significant international pressure to play a leading role in tackling the climate crisis and has shown strong willingness to do so through the development of clean energy technology.
Although China is one of the largest carbon emitters globally, representing 30% of worldwide emissions and 50% of coal consumption, it is also the leading manufacturer of clean energy solutions. China controls 70% of global solar module production, manufactures almost half of the world’s wind turbines, and accounts for 40% of renewable energy vehicle sales.
Companies at the forefront of this clean energy revolution are the ones to watch, as China aims to achieve carbon neutrality by 2060. This means clean energy will shift from being a peripheral source of energy in China to the predominant source over the coming decades, while fossil-fuel emitting companies will be forced to adapt.
Housebuilding is another area where government policy has shifted to a more environmental focus. While Europe is often perceived as the driver of the decarbonisation agenda, China’s ambitious plans should not be underestimated.
Under the latest Five-Year Plan, 50% of new buildings are expected to be green certified. This shows China will play its part in addressing the climate crisis and investors should be ready for the new direction of travel.
Investors may have shown nervousness about changes underway in China, but they should not write it off.
There are several positive macroeconomic and microeconomic developments that point to the long-term investment case for the country, from a growing consumer base to improving competition in the private sector and the development of clean, green technologies.
Understanding these shifting dynamics and being nimble enough to respond to them through a style-agnostic approach is key for investors to realise the many opportunities that exist in Chinese markets.
Jian Shi Cortesi is investment director of China and Asian equities at GAM. The views expressed above are her own and should not be taken as investment advice.