The general view from overseas investors is that the ongoing trade conflict with the US is impacting China as it targets China’s key export sector. However, it has been clear for many years that China’s economy has been moving away from relying on exports and towards consumption-led growth.
That said, China remains the world’s key manufacturer as its sheer scale enables it to produce products incredibly efficiently. Supply chains are so broad and embedded and the sheer number of (highly educated) workers makes it difficult to replicate. At the margin, trade tariffs may cause some manufacturing to move, but this will more likely be to low cost neighbours such as Vietnam and Indonesia rather than the US.
Deleveraging has been a major drag on activity
The main reason for the current economic slowdown in China and the knock-on impact on company earnings is the government’s pursuit of deleveraging - an action many China sceptics have been calling on for years. The rapid rise in debt levels have been well documented and clearly has become a greater priority for the government over the last couple of years. Tighter lending conditions has had a marked impact on business and consumer confidence as smaller companies in particular have found it more difficult to find funding for investment.
Trade rhetoric and slowing growth has consequently impacted consumer confidence, a bedrock for recent China gross domestic product (GDP) growth. 2018 GDP data showed 6.4% growth - still an enviable rate of growth in a global context - and consumption continues to grow faster as the rebalancing continues supported by an expanding middle class.
We have seen a fall in retail sales to high single digits, with high ticket purchases seeing a more significant adjustment - the auto market has seen its first decline in over two decades. However, there have been pockets of strength in the consumer space, with areas like domestic sportswear, baijiu (rice wine) and ecommerce remaining strong albeit still slowing.
China’s structural growth story remains intact
Despite the slowing environment, there are still abundant investment opportunities across China’s equity markets. First, strong structural growth drivers remain in a number of sectors. Growth rates still stack up well versus most markets. Secondly, much of the negativity around slowing growth seems to be priced in - many companies currently trade at extremely attractive valuations versus their own history and global peers.
Importantly, this backdrop creates a diverse opportunity set where the growth rate is not homogenous across different areas. This is where our locally-based research resources can really add value by identifying winners that are overlooked by the broader market.
For example, Fidelity China Special Situations PLC holds significant positions in insurance companies and brokers, who are trading at attractive valuations. There is a structural shift from banks to non-banks as individuals reallocate savings (the savings rate in China is significant) to other financial products. I currently prefer life insurance companies as penetration is lower, less developed and is greatly linked to China’s rising wealth.
The portfolio also owns the bigger institutional brokers like CICC and CITIC Securities. They have more sustainable income from financial institutions and foreign players and are key beneficiaries of the opening-up of the A-share market.
So, despite the well-recognised near-term challenges facing China, there are still opportunities for discerning investors willing to take a longer-term view. The structural growth in demand and rise of the middle class continues to play out and it is evident that areas related to how and what Chinese people consume will continue to outgrow the overall economy.
It will be very difficult to derail this structural shift and China’s core entrepreneurial spirit and human capital cannot be overlooked, particularly given the government’s clear and long-standing policy intention to shift towards a consumption-led economy.
The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. This trust invests more heavily than others in smaller companies, which can carry a higher risk because their share prices may be more volatile than those of larger companies. The trust also uses financial derivative instruments for investment purposes, which may expose the fund to a higher degree of risk and can cause investments to experience larger than average price fluctuations. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser. Investors should note that the views expressed may no longer be current and may have already been acted upon.