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2024 Outlook on the China Market
In 2023, the Chinese market has been a year of volatility and policy-centric (reopening and deleveraging). Looking into 2024, there’s potential for improved confidence and market recovery, while growth and inflation could be the two main areas of focus.
The main drag of China’s economic weakness is problems rooted in the real estate industry, which have affected property developers and local government finances, and have ultimately spread to the broader economy. As housing represents 60-70% of assets for the median household in China1 , it is also a deeply psychological issue (apart from the wealth effect). Also, this year showed that the mantra to “invest less, consume more” is not suitable for China at this stage.
The current cyclical problems could be resolved through aggressive fiscal expansion, facilitated by monetary easing. This would boost growth and help asset prices recover (reflation) in 2024.
We believe the sentiment regarding China has gotten too negative, given the array of recent simulative measures and the likely reversal of the US tightening cycle. Any positive development in the economy or policy surprise would trigger a market rebound.
In the past few years, Chinese policymakers decided to shift away from the land-fiscal model and focus on quality growth. Despite the painful deleveraging process, especially on the cyclical side of the economy, we see some silver linings coming out of the process.
Policymakers have shifted more focus towards technology-driven innovation, especially in hard-tech (i.e. semiconductors, advanced manufacturing, info-tech, etc.) instead of soft-tech (i.e. online gaming, e-commerce, etc.). This strategic shift is intended to stimulate technology innovation and industrial migration to interior provinces while also enhancing supply chain resilience amid geopolitical uncertainties. This will profoundly impact the foundation and direction of Chinese technology and manufacturing economies in the long term.
Another beneficiary is the green economy. China has become the largest exporter in critical strategic sectors like electric vehicles (EVs) and solar and wind power. In EVs, for example, China went from being a net importer in 2019 to being the largest net exporter in 2023.2 Similarly, China has embedded itself within the renewable energy supply chain, which should lead to growing Chinese exports as demand for components grows. By positioning itself as a low-cost producer in high-growth sectors of the global economy, China has likely secured additional growth for years to come, even if it might be blocked from US markets in some cases.
Sectors/subsectors with the best opportunities
As we look towards the investment landscape of China in 2024, our outlook for equity investors hinges significantly on the trajectory of government policies. If policymakers double down on a robust fiscal policy, particularly in areas like affordable housing, we anticipate a positive ripple effect on consumer sentiment that could buoy consumer-oriented sectors, particularly in names that have de-rated to attractive valuations this year. This would also potentially invigorate cyclical sectors that would benefit from an improved economic landscape – e.g. sentiment towards construction, real estate, and financial services sectors could turn positive as the effect of housing policies becomes more visible.
On the other hand, should the policy emphasis shift towards a more muted fiscal approach, then our focus would remain on identifying sectors/alpha plays that are not highly dependent on cyclicals. For example, several opportunities in IT and artificial intelligence (AI) are poised to continue their growth trajectory independent of broader cyclical trends, offering alpha opportunities for investors seeking growth in less economically sensitive areas. We expect these sectors to benefit from global digital transformation trends and China’s commitment to technological self-sufficiency, making them attractive regardless of cyclical economic shifts. In either scenario, focusing on quality and aligning investment strategies with the nuanced policy shifts will be crucial in identifying opportunities primed to outperform.
Understanding the chaos and conflicts of China’s political economics
If we look deeper into why this policy cycle has been different to the past and the fundamental drivers behind past policy framework adjustments, we need to peel into some of the structural issues.
1. Deleveraging and centralization of power
The Chinese land-fiscal growth model is a high-savings, high-investment model. After initial decades of healthy and efficient growth, debt-driven growth becomes unsustainable and ends up with very high investment rates that are no longer productive. However, fundamentally shifting the growth model is a difficult process, as previous successes benefited segments of the economy disproportionately. Decades of excessive investments in these sectors created powerful institutions that have strong vested interests in the prevailing model and hinder any transition into a new one.
In the case of China, it is mostly in the form of local government and property market (which also carried most of the debt). This partly explains the re-centralization of economic decision-making because the conflict over adjustment would be so difficult that without a re-centralization of power or regulations from the central government, provincial government and property enterprises lack the incentive to reform.
That is partly why there’s chaos, lack of confidence, and inefficiency in China’s policy execution, as most of the fiscal and monetary policies relied on the execution of those institutions (i.e. local government and financial institutions). Among other side effects of the re-centralization of power and institution reshuffle, the Tacitus trap could be one of them behind the weak confidence and poor policy response.
Despite the difficulties, with the right reforms, policy execution, and communication, there is a path to it. Just within the modern history of China, in the 1980s, a series of reforms were ferociously opposed by the party, but with a highly centralized leadership, they were able to implement the reforms. Meanwhile, in the 1990s, the central government was also able to carry out major restructuring/reform and model shift, which led to the fast growth of the following decades.
2. Geopolitical confrontations
China represents roughly 18% of the global GDP and accounts for ca. 30% of global manufacturing.3 Thus, how China’s growth model changes will have large implications for the world. Many compare China’s current situation with Japan. If we look at Japan’s case, we see consumption growth remain stable or in a mild decline while much of the adjustment is incurring with the reduction in investment. Hence, the current account deficit as a share of global GDP will contract, along with a currency appreciation. This would be a less confrontational model shift from other major export powerhouses’ perspectives; however, not investing in emerging industries is one of the key reasons for the lack of growth in Japan’s so-called “lost decade”.
From the recent policy direction, China seems to be offsetting the slowdown in property investment with an increase in industrial investment from policy support. That will inevitably create conflicts for many major export economies, as they might need to reduce their own manufacturing share. This could be one of the key reasons behind the slow progress of major trade deals among major developed markets and geopolitical conflicts, partly contributing to seemingly inward-looking policies. This would also have exacerbated domestic deflationary pressure as well.
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