What a difference a year makes. This time a year ago, China had was nearing pariah status.
It had unleashed a deadly and costly pandemic across the globe and attempts to offload responsibility through clumsy PR had done little to improve its international standing.
Companies looked set to shift supply chains to more reliable partners, threatening China’s manufacturing power base.
Quick about face
Scroll forward 12 months and China is the only major economy to have delivered positive growth for 2020, which has now returned to its pre-pandemic projected level.
Its early and decisive action on the pandemic has helped manufacturing return to normal.
The international business community appears to have forgiven and forgotten.
Growing exports have helped support growth and shifting supply chains across the globe have benefited as much as they have detracted.
The IMF has said it expects China, along with the US, to recover fastest from the pandemic and is currently predicting 8.1% growth for 2021.
Importantly, this recovery appears to have been evenly spread across the economy. While exports have been the strong point this year, services output has also returned to pre-pandemic trend levels.
Investors have recognised and responded to the shift.
In 2020, China overtook the US as the world’s top destination for new foreign direct investment.
The Blackrock Investment Institute said: “We expect persistent inflows to Asian assets as many global investors remain underinvested and China’s weight in global indexes grows.”
Investors remain underweight China relative to its share of the global economy and are in the process of catching up.
This has been reflected in the performance of Chinese assets over the past 12 months. The FO – Equity China and Greater China sectors top the league tables over one year, with the average fund up 47.3% and 46.8%, respectively.
Chinese stock markets have continued that strength even amid the rotation to value areas since November.
Warren Hyland, emerging market portfolio manager at Muzinich & Co expects economic strength to continue: “There is considerable pent-up demand from consumers, particularly because many can’t travel and will therefore spend their money domestically.
“This is likely to replace government spending in 2021 and exports will keep growing.”
China’s economic growth machine appears to have been largely untroubled by the pandemic.
Opaque and slow to embrace ESG
That said, there are caveats. The pandemic has not been without consequences for the Chinese.
It has exposed an uncomfortable lack of transparency at a time when global capital increasingly wants to invest sustainably. While China undoubtedly has prowess in areas such as electric cars, it is behind the curve on ESG more generally and its human rights record is poor.
This may deter investors.
There are also questions on future growth. The US corporate sector has realised that access to China’s vast consumer markets is not a ‘free lunch’ – it can mean giving up intellectual property rights, for example.
Hyland says that US companies are notably less supportive than they used to be. It also means that Chinese companies are likely to be denied access to the wealthy US market – TikTok and Huawei representing the tip of the iceberg.
With many Chinese companies looking for non-domestic sources of growth, this could be a problem.
Change of the guard
New president Joe Biden is unlikely to come to China’s aid.
Anthony Willis, investment manager at BMO Global Asset Management, said US policy towards China would likely remain adversarial and pointed to recent comments from Janet Yellen, incoming Treasury Secretary, saying: “China is clearly our most strategic competitor” and that the US needs to take on China’s “abusive, unfair and illegal practices”.
“The tone may differ from the Trump administration, but it seems unlikely we will see the trade tariffs rolled back in the near future.”
China’s response both to these hostilities and the pandemic has been to look at ways to become more self-sufficient.
In response to being cut out of the US semiconductor market, for example, it has sought to build its own.
Investors certainly shouldn’t bet against China being able to manage on its own or with the help of its Asian neighbours.
Intra-Asian trade continues to grow and the region is loosening its ties with its Western peers.
In the shorter-term, however, a greater threat to the ongoing strength of Chinese assets may be their recent success.
Chinese equities have been subject to the same problems as US equities – the gains have come from a relatively narrow base of high profile technology companies and those companies now look expensive.
Should the ‘value’/reinflation trade take off in earnest, China will not be the place to be invested.
Equally, there are risks around the currency.
If China eases up on government spending, that is usually a fallow time for Chinese assets: Hyland points out that renminbi tends to do better at times of deflation because the Chinese buy locally.
Against all expectations, China has been a great place to be invested over the past year.
However, as other countries get to grips with the virus, it may not sustain its relative advantage over the coming year.
While the economic numbers look strong, there are notable risks to the continued success of its stock markets.