Will Scholes, co-fund manager of the Premier Miton Emerging Markets Sustainable Fund, hits the road and shares notes from the team’s company research trip to China.
For information purposes only. The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
Small talk: traffic and the weather
Late September proved a beautiful time to visit China. From Shenzhen in the South to Hangzhou and Shanghai in the East, and further north to Beijing, we moved from tropical heat to balmy autumn sun, with broad-leaved Chinese oaks turning in colour. No sign of the terrible floods that had swept through Beijing, Hong Kong and other cities in the region the week before and killed hundreds. And, no smog. Which was surprising because there was no shortage of traffic. In fact, despite an agenda that took us to 5 cities in 5 days, the smallest city we visited – Hangzhou – is 30% larger by population than London, while the largest – Shanghai – weighs in nearly 3 times the size. Everywhere, roads were full.
Comparing relative costs of living from the bottom-up is a good reminder of what China has more of, and what it has less of. A (fairly high-end) coffee in a mall was more than £4.50, but a 25-minute ride in a (fairly worn-out) Didi – an Uber equivalent – was roughly £2.00. We’ve no plans to inaugurate a competing “Big Mac Index”, but maybe the two represent a facile analogy for the still-high availability of human labour on the one hand, versus the greater expense of imported equipment, certain natural resources, and of course full-time employment on the other. That we were even drinking a coffee on-site marked us out as foreigners as much as our halting translation apps: most people have them delivered to their desks by other workers across the gig economy.
Back to the traffic. A rather different “BMI” – the Baidu Mobility Index – is pointing up at the moment, unlike many high frequency indicators in China. Chinese households are travelling domestically, but they are sticking far more to their cars than usual, which is why road congestion is up, while public transport is down. So much is true across many economies around the world following the coronavirus pandemic. But, while in economies like the UK we might link this to a change in commuting patterns tied to hybrid working, could it perhaps represent in China a lingering fear of the virus? After all, the official rhetoric in China was considerably more fearmongering than in the Western world. At one point, ‘long Covid’ was even held up as a chronic affliction that would undermine Western economies wholesale. Yet, we saw not a bit of it: offices we visited were full to capacity. And with China leading the world on electric vehicle penetration (forecast at 31% of all auto sales in 2023 according to canalys.com), the impact on air pollution is much less acute.
At this point, it’s worth acknowledging the limited and biased view of China any visiting investor can get, even with a busy schedule of companies across diverse industries. Fund managers tend to visit companies with appealing prospects, where vacancies are likely fewer. Full offices likewise tell you little about stock lying un-sold in warehouses. And most of all, tier 1 cities such as we visited do not give you a picture of prosperity in tiers 3 and 4. Seen through the lens of property prices, this disparity comes into focus: a large real estate agency network operator we spoke to told us that real estate values were down 5-10% in tier 1 cities, and down 30-40% in tier 3s and below. Kenneth Rogoff and Yuanchen Yang’s paper from 2022 puts the contribution to Chinese GDP by these tier 3 cities at more than 60%.
Here the negative wealth effect has hit hardest, not least since Chinese households are estimated to have between 70% and 80% of their wealth tied to, or up in, property. And, while it has become something of a cause for commendation that Emerging markets are suffering fewer long-run effects of inflation and fewer labour dislocations because they handed out less in Covid support, nevertheless in markets with little social security or safety net, not to mention a workforce closer to retirement than the start of their career (like China), the price to be paid is deferral of consumption as cash is stashed on deposit rather than spent, and perhaps ultimately deflation.
With all that in mind, it has become popular to compare China’s outlook to that of Japan in 1991, as it commenced what later became known as its ‘lost decade’. There are many large flaws in this, not least relative wealth per capita, and relative valuation of real estate (Japan was world leader in both, China is not), but it’s a comparison that does yield one interesting observation. Over the ten years ending early January 2001, Japan’s market cap-weighted index in Tokyo – the Topix – lost you a little over 1% per year in US dollar terms. Hence the ‘lost decade’ after years of stellar growth, supercharged by a strengthening currency.
In fact, the Topix peaked at the very end of 1989 in US dollar terms and would not convincingly bottom out until a few years later, at the end of April 2003 – an annualised peak to trough loss of 8.2% per year. Over the same period, you might have earned a little over 7% per annum simply investing in the S&P 500. Yet, a full 34 companies in Japan would deliver an annualised return of more than 7% in the 10 years preceding that market trough, despite the economic malaise.
These were global leaders in thriving export industries, not just semiconductors, but software, pharmaceuticals, industrial motors and robotics. China faces a trickier situation competing in semiconductors today, constrained as it is by trade restrictions. But there are clear parallels here with China’s leadership in clean energy, battery technology and rising competitiveness in automation equipment and electric vehicles. Large economies shunned by global investors can none the less play host to first class companies trading cheaply.
Closing the loop
We came away encouraged by our findings, and by candid management teams keen to engage with foreign investors. We also came away a little more practised at paying for everyday items inside China’s closed loop system of payment by QR code, inside smartphone apps that double up for directions, translation, menu-reading, customs declarations: anything you might need. Much like with electric vehicles or the legions of electric 2-wheelers, China has leap-frogged Western countries to arrive faster at a cashless society, by means of payment at least. Meanwhile, cash as store of value (on bank deposit) piles up.
China’s trade surplus has grown to 5% of GDP. In fact, stripping out commodities and looking solely at the manufacturing trade surplus, the levels are the highest since the mid 2000’s. A lot has been made of global decoupling from China, but this may not be happening as fast as it appears at first glance. Rising imports to the EU or US from Vietnam and Mexico are in fact as likely to be from Chinese companies with new assembly in those locations, as they are to be ‘new’ trade partners.
Meanwhile, not enough has been made of the speed at which China itself is trying to decouple. China’s trade with developed nations is now considerably less than its trade with the Emerging world. This was not the case just a few years ago. Emerging markets are less likely to complain of one-sided trade and propose trade barriers, which is useful when your relationship with the US and Europe has soured. All the while, China works tirelessly to replace imported goods with its own production, with varying degrees of success. We met firms producing medical devices and factory automation equipment, as well as data centre cooling systems at a level of quality on par with global peers.
This approach to trade is one large cog in a global movement to more regionalised economic centres. But the players involved – principally China and the US – are simply too big for that scenario to play out in full. Trade imbalances will continue to come to a head. Squaring that circle, we come back to China’s lack of consumer economy. But households need to feel that medium term economic prospects are improving, job prospects are sound, and that the stores of value made available to them – which remain principally property-related – are underpinned. Without social security, or bold fiscal policy to reorient the economy, this is a tall order. While the risks are high, in China’s closed financial system the stock of unfinished housing inventory can be cleared in time, developer debts can probably be restructured and still more infrastructure can be built to sustain growth. China will do so from a position of economic resilience, with high cash reserves and high export values. The cost will be economic value, and above all, time.