China's economic shift uncovers hidden investment gems

By Newsdesk

December 11 2023
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Investing insights often uncover silver linings in challenging economic landscapes, and this is precisely what Iain Cunningham, Head of Multi-Asset Growth at Ninety One, highlights in his recent discussion on China's current financial environment.

China's economic shift uncovers hidden investment gems

Cunningham delves into the structural and cyclical headwinds facing China, from real estate imbalances to geopolitical tensions, and illuminates the potential for investment opportunities that arise from these adversities.

"The primary structural challenges are fourfold: a real estate imbalance, a local government and state-owned enterprise leverage imbalance, weakening demographics and geopolitical headwinds," Cunningham explains. The real estate sector, having been a major driver of growth, now presents a significant headwind, with investment in the sector having peaked in 2014. Current trends indicate a shrinking real estate sector in proportion to China's GDP, making it less attractive for investment in Cunningham's view.

With the economic strain in recent times, Chinese authorities have been softening the macroprudential measures established in 2021, simultaneously applying targeted stimulus to stabilise the real estate sector cyclically. However, the pivot to address local government and state-owned enterprise leverage has been a substantial step, with Chinese authorities committing to a comprehensive debt solution to underpin weakened growth resulting from earlier clampdowns on "hidden debts."

These steps towards managing the financial health of local governments have seen recent debt swaps and a directive to state banks to refinance debt at lower interest rates, effectively a bailout allowing local governments to remain operational but also generating profit headwinds for Chinese banks.

In the realm of international trade and investment, "de-risking” and supply chain restructuring have prompted a redirection of foreign direct investment and adjustments in Chinese exports to the United States. Cunningham offers a vision of a "multi-polar world," where although there is reduced connectivity with the developed world, the interconnectedness of global economies renders a complete decoupling impracticable.

Despite these challenges, Cunningham remains optimistic about China's ability to manage its economy, underpinned by its characteristics as a command economy with a relatively closed capital account, which provides more leeway than other countries have in managing imbalances—allowing for continued financial support for sectors in need without relying on international funding.

Looking ahead, Cunningham anticipates a more favorable outlook for the Chinese economy, forecasting continued growth—with gains in productivity—and identifying sectors that will prosper amidst the ongoing shifts. He projects a decline in real estate's contribution to GDP and expects the banking system to absorb losses, while trends like premiumisation and localisation, digitisation, medical technology, and the strengthening of financial institutions due to pension reforms should all flourish.

Amidst the current climate of uncertainty and pessimism, Cunningham suggests that "great companies in China can be acquired at very attractive valuations." This perspective opens up a dialogue on how investors might navigate China's intricate financial landscape to identify and capitalise on the prospects therein.

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