Longer-Term Outlook: Xi Thought Shapes the Investment Landscape
Over the long term, of course, the ideology of President Xi—known as Xi Thought—is the overriding force behind China’s structural policy and outlook. This was underscored recently at the National Party Congress (NPC), during which Xi secured an unprecedented third term in office.
Xi’s secure position will help promote the kind of growth he aims to achieve, in our view. That means driving innovation, supporting manufacturing, lifting income per capita, reducing wealth inequality and pursuing further market reforms. The bottom line? While growth targets could become more flexible in coming years, sustainable long-term growth remains critical to China’s plan for a stable and more equitably wealthy society.
China’s trajectory is not unique: other Asian countries, such as South Korea and Taiwan, have followed similar paths in the last two decades. Growth slowed and their governments, in the interests of social justice, became more interventionist (though less so than China’s).
But it’s remained possible to invest successfully in those countries by carefully selecting stocks based on rigorous fundamental analysis. Similarly, the key to investing in China’s maturing economy, in our view, lies in both reading policy correctly and seeking out company-specific opportunities that are aligned with the policy direction.
Identifying Policy-Driven Opportunities
Policies with medium- and long-term horizons are particularly interesting for investors. At the NPC, the government reaffirmed further restrictions on property speculation, the pursuit of common prosperity and security.
While the investment implications of a crackdown on property speculation are self-evident, the pursuit of common prosperity raises the likelihood of inheritance and property taxes—and an increase in social safety net measures such as affordable housing and better social services.
Security, in the Chinese context, has external and internal dimensions. It refers to geopolitical risks (such as relationships with the US and its allies, and with Taiwan) as well as internal strategic security, through independence in energy and technology.
Heightened geopolitical risks are a significant concern for investors. Yet some external geopolitical risks have eased, for example, concerns about the delisting of ADRs while some internal strategic issues can have positive implications, in our view. We expect them to translate into increased investment in solar and wind energy generation and a continued focus on domestic semiconductor manufacturing.
China’s goal of carbon neutrality by 2060 is an important long-term policy direction. Alternative-energy enterprises and businesses in the electric-vehicle supply chain should be on investors’ radar, together with companies aligned to other policy areas.
How can investors turn these policy-driven opportunities into investments?
Focus on A-Shares, Policy-Aligned Sectors and Fundamentals
For equity investors, the best place to look, in our view, is the domestically focused A shares market. Compared to the internationally favored H shares market, it’s bigger (with more than 4,600 stocks compared to less than 300 for the H shares market) and less exposed to geopolitical risks. The A shares market also offers more companies poised to benefit from the domestic policy framework.
Consider the focus on sustainable growth, which involves regulatory support for state-owned enterprises (SOEs) and a redistribution of profits to consumers. This will make it harder to find high-growth opportunities in, for example, internet and biotechnology stocks. But sectors dominated by SOEs—such as financials, materials or traditional retail—will become more attractive.
As well as taking policy-driven opportunities into account, investors must consider the impact of lower long-term economic growth on Chinese companies’ profitability. When viewed through a value lens, investors can identify companies with more resilient profitability potential trading at attractive valuations. And sometimes, policy and company fundamentals can intersect in surprising ways that creates a sweet spot for contrarian investors.
For example, China’s 2021 regulatory tightening of private education triggered widespread declines in the sector. However, one SOE that had a monopoly on textbooks bucked the trend. Its sales of test-preparation materials soared, because students still needed to take exams.
The value approach can also work independently of policy considerations. An A share company best known as a maker of monosodium glutamate also had a share of the global market in xanthan gum, a thickening agent used in everything from salad dressing to oil drilling. As the global oil price rose sharply, so did its profits.
China Offers Opportunities and Diversification
China has become a slower-growth and more policy-directed economy. Investors who hanker for the old high-growth days might be disappointed, but such a glass-half-empty attitude, in our view, could mean that they miss out on what China has to offer.
Capturing the opportunities requires an appropriate mindset—one that sees less break-neck growth as offering the advantage of sustainability, and clearly articulated and judiciously applied policy as offering stability. It also requires an investment strategy that is alive to opportunities created by policy directives and discovered by rigorous fundamental research and careful stock selection.
China remains uniquely China. As a jurisdiction and investment market that marches largely to its own drum, it continues to be a valuable source of diversification for global equity allocations.