Above all this year, China will put itself first – hence the ‘dual circulation’ philosophy it has adopted – even as it opens its capital markets to foreign investors, thereby giving them easier access to the China story. In 2020, China overtook the US to become the leading recipient of foreign direct investment – how long before it takes top spot for foreign portfolio investment?
At the very least, everyone will need to keep a close eye on developments.
For income, China bonds yield to (almost) none
Perhaps nowhere is China more ox-like than in its bond markets. Resolutely committed to orthodox monetary policy long since the rest of the world’s major economies abandoned it, Chinese authorities show no sign of diverting from their lonely furrow. As a result, China remains the only large and liquid fixed income market with positive real rates.
At the start of a new Chinese year, while developed bond markets are anxiously trying to figure out if we are entering a reflationary trend – which will herald the end of ‘lower for longer’ interest rates and the unconventional policy approaches that have accompanied them – Chinese bonds offer the prospect of continuity and carry.
More international investors are climbing aboard. In 2020, foreign inflows into onshore CNY bonds hit a new record of over US$150 billion. We expect the mainstreaming of Chinese bonds to accelerate this year, spurred by the imminent inclusion of China to the FTSE World Government Bond Index.
While China’s monetary policy remains firmly conventional in terms of its overall approach, its bond markets are far from static. For example, the Chinese corporate credit segment is continuing to mature, as regulators dismantle the perceived ‘state put’. This will pave the way for a healthier differentiation in credit spreads based on fundamentals, rather than proximity to the state. The broader point is that while we expect China’s bond markets to power along the same track they have ploughed for some years now, we should still expect to encounter the odd bump along the way. The resulting dispersion and volatility, around a steady channel, should make it an interesting year for active investors.
Tech’s appeal: spotlight on China’s technology sectors
The year of the lumbering ox it may be. In technology, however, China is all too aware that slow and steady will not win the race. The headline trend is for an acceleration of China’s technology industries, which will present opportunities for investors. But the currents and crosswinds here are complicated, so care will be needed.
Communiqués on the 14th five-year plan (to be confirmed in March) emphasise innovation and technological self-sufficiency, which suggests Beijing will try to speed up the ‘decoupling’ of domestic tech sectors from their international peers. In the US, a tough stance on trade with China has bipartisan political support, so the change in White House administration will have done nothing to assuage Beijing’s dislike of being reliant on foreign know-how.
Broadly, we see tailwinds for select parts of the tech universe as China continues its march up the production value chain and brings more key technologies within its borders – which also implies headwinds for some hi-tech suppliers to the country. But investors seeking to tap this growth potential need to watch their backs, because there are two 800-pound gorillas in the room (animals that don’t share the ox’s even temper).
The first is the US, which in January tightened restrictions on several Chinese companies, including a leading mobile-phone maker, on national-security grounds. We see no easing of the risk of sanctions and counter-strikes, which may cause volatility in tech stocks within and outside China. Longer term, however, the growth of China’s tech sectors seems unlikely to be stunted.
The second is China itself. Shares in the country’s tech giants fell sharply late last year after Chinese regulators moved to implement antitrust laws that would curb their power. This policy shift could have major ramifications for China’s wider tech ecosystem. But it hardly seems in the Chinese government’s interest to dismantle the national tech giants, which have provided significant economic and productivity gains.
Riding China’s green wave
When President Xi committed China last September to net-zero emissions by 2060, he set the world’s second-largest economy on a path towards a significantly faster decarbonisation than had been expected.
China is by far the world’s biggest emitter of carbon, accounting for 28% of the global total.
Consequently, carbon neutrality will require a radical overhaul of China’s energy grid, transport system, built environment and much else besides. That suggests enormous potential growth for the companies enabling decarbonisation, and we think creates a powerful structural-growth trend for investors to tap into.
Environmental-sector development is high on the agenda in the upcoming five-year plan, not least because it supports China’s national-security aspirations and ‘dual circulation’ strategy, which places more emphasis on internal production and consumption to balance export-fuelled growth. Clean technologies could help China become self-sufficient in energy, given that about 70% of the oil refined in China is imported.
Decarbonisation is a highly disruptive process and the journey from here to net-zero, should we get there, will not be without stumbles and wrong turns. We therefore favour an active and highly selective investment approach.
Strong as an ox? Economic trends for investors to watch
Strength is among the ox’s signature characteristics, and the Chinese economy certainly displayed it in 2020. Q4 growth of 6.5% brought the annual GDP increase to 2.3%, making China the only major economy to avoid a contraction in a year dominated by the pandemic. According to some calculations, that puts China on track to surpass the US as the world’s largest economy in 2028, a couple of years earlier than pre-COVID estimates.
We already know that China’s ambition is to raise per capita GDP to the level of “moderately developed countries” by 2035. Domestic media think this is about US$20,000, compared to about US$10,000 now. That would require a minimum growth rate of 4.7% over the next 15 years, suggesting a continuation of the gradual growth slowdown in recent years.
Increasing average incomes and growing China’s middle class are crucial to China’s ‘dual circulation’ strategy. A core element of the 14th five-year plan, dual circulation puts more emphasis on domestic consumption to drive growth and reorients production to meet the needs of Chinese consumers – though exports will remain important. These changes to production and consumption patterns clearly have implications for investors, since they alter the growth potential of individual sectors.
So while China turns its focus somewhat inwards in the face of what it perceives as an increasingly hostile world, it should continue becoming easier for international investors to access the abundant investment opportunities that China will offer in the year ahead and the decades beyond. DM/BM
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