Cash & Liquidity ManagementInvestment & FundingInvestors play down China trade war fears as domestic market soars

Investors play down China trade war fears as domestic market soars

Despite a potential China-US trade war, the Asian giant is still investors' favorite growth story thanks to a burgeoning domestic market, writes Simon Milne.

A developing theme in global asset management is exposure to China. S&W Aubrey Collective Conviction Fund trimmed its weighting to last year’s success story India earlier this year, however, China is now the business’ favorite emerging market story alongside Vietnam. India is temporarily on pause while the election cycle passes. 

We think it is China, not the US, that is likely to determine the probable investment narrative for the next century, yet the iShare MSCI ACWI ETF, the notional benchmark comparator that we use to measure our performance, allocates a paltry sub 3% weighting to China.

China’s allocation is roughly half that of the UK and less than Canada’s, yet China’s economy is currently second only in size to the US. It will be the largest by 2030, according to the Centre for Economics and Business Research, and it already has a population almost five times that of the US.

Ten years ago, the beneficiaries of Chinese resurgence could be found in Brazilian or Australian commodity producers or through consumer staples companies such as Unilever, but this is no longer the case. The current and future corporate beneficiaries are and will be, Chinese.

Already technology giants such as Tencent and Alibaba have market capitalizations equivalent to their American peers. Ironically, while the US government often berates companies such as Facebook and Amazon, the Chinese government actively champions their domestic equivalents, while excluding US competitors. China is also a country where personal privacy has been surrendered years ago, and where data capture potential is infinite and entirely accessible by the state.

“Ironically, while the US government often berates companies such as Facebook and Amazon, the Chinese government actively champions their domestic equivalents, while excluding US competitors.”

China is not just a story about technology and electric vehicles but is broadening out to include consumer, healthcare and educational companies, amongst others. We do not know what a ‘correct’ weighting to China should be in a fund such as ours. We estimate it to be currently around 9%, but we feel it should be much higher than conventional benchmarks suggest, and we would expect this weighting to rise over time as passive index-hugging investors realize the opportunity.

Of course, there are risks to our increasingly positive scenario. Notably, investors are currently concerned about some sort of trade war breaking out between the US and China and has already put downward pressure on Chinese equity markets. However, this provides what we believe to be a prescient opportunity to enter the market for those who believe the country’s longer-term story.

We cannot be sure of the outcome of the current US-China trade spat but if past evidence is anything to go by, perhaps US President Donald Trump’s bellicose Twitter rants will turn out to be initial negotiating positions, rather than end-point policy statements. China seems to know this, responding shrewdly with promises of targeted retaliatory tariffs directed at the core political base of Republican Party, and specifically Trump, supporters.

“We cannot be sure of the outcome of the current US-China trade spat but if past evidence is anything to go by, perhaps US President Donald Trump’s bellicose Twitter rants will turn out to be initial negotiating positions, rather than end-point policy statements.”

Indeed, the latest statements out of China have been conciliatory, with President Xi Jinping talking of how he wants to open the country to foreign investment and competition. While what the Chinese say and what they do could turn out something different, the point is that the investment case for China now is not built on its old, export-orientated industries to which Trump objects so vociferously, but to domestic consumption which is rapidly taking off within China.

The adage for foreign investors in China was to read the last five-year plan from the Chinese Communist Party (CCP) and watch it happen. That is as true today as ever. In the current plan, the CCP is looking to turn their centralized economy 180 degrees away from the old export model towards a new domestic consumption-led economy and are doing everything in their power to achieve this. Additionally, Trump understands that he needs Xi’s help with two of the most challenging strategic issues on his global agenda: nuclear weapons programs in North Korea, and Iran. We believe he will not risk jeopardizing these higher goals with an overt trade war.

So where do we think the honey lies in China? It might be in deep value financials and old economy manufacturing stocks that dominate the indices, but we will leave these to cleverer investors than us. We prefer to invest under the radar of the Exchange Traded Funds and index-huggers, in mid and small cap growth stocks that are focused on the Chinese consumer, and therefore not buffeted by macro calls on trade, currencies and interest rate policies. Such companies tend to be highly entrepreneurial and many can be found in the burgeoning healthcare, fintech, educational, electric vehicles and technology sectors.

“We prefer to invest under the radar of the Exchange Traded Funds and index-huggers, in mid and small cap growth stocks that are focused on the Chinese consumer, and therefore not buffeted by macro calls on trade, currencies and interest rate policies.”

The China Securities Regulatory Commission, as well as piloting a programme for China Depositary Receipts so that overseas-listed Chinese companies such as Baidu, Alibaba and JD.com can have a domestic listing, has also just granted the right for the so-called Chinese ‘unicorns’ to proceed to IPO on the domestic market. There are well over 100 such companies, among them Ant Financial, Alibaba’s fintech giant, MUI (electronics) and Didi, China’s Uber. It is these names that we find the most attractive, and where we feel the best returns will be made over the course of the next 10 years, if not the next century.

 

 

 

 

 

 

 

 

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