When China came out of COVID-related restrictions last year, those anticipating a swift return to its previous economic prowess would have found themselves greatly disappointed, according to Dan Farmer, MLC Asset Management chief investment officer.
While Mr Farmer said that some parts of the economy did rebound – such as domestic tourism, hospitality, and retail services – he conceded that “a China that buys less from the world, or invests less globally, will be an economic handbrake”.
He warned that the last couple of years have panned out unexpectedly, as China, a country where property accounts for around 70 per cent of household wealth, is now riddled with mortgage strikes.
“Add to this mix massive debts racked up by local governments that, up to now, have used land sales to raise revenue and it’s a disturbing picture,” Mr Farmer said.
“Meanwhile, soft durable good consumption trends, weak private sector investment rates, and households emphasising saving are all pointing towards profound structural issues with ‘no solution in sight’,” he continued.
Mr Farmer stressed that China’s economic trajectory “matters to the world” and is especially pertinent for Australia as the prosperity of local natural resources companies, education providers, the tourism industry, and wine producers, among many others, are bound to China’s fortunes.
As such, MLC AM contended that China’s traditional manufacturing-centric growth model, which had been in place for decades, may no longer offer the same level of effectiveness, especially as policymakers acknowledge that the construction of new infrastructure such as highways, airports, or cities might yield only marginal benefits.
“That’s why Beijing has not announced another massive old-school stimulus program,” Mr Farmer said.
“What to do about this, so that China doesn’t fall into the ‘middle-income trap,’ is historically important.”
Mr Farmer described the “middle-income trap” as a scenario where a country faces challenges competing on the global stage in labour-intensive industries due to comparatively high wages, yet simultaneously struggles to engage in higher-value-added activities at a scale large enough due to lower productivity levels.
“Consequently, there are fewer avenues for further growth. Arguably, this is now China’s situation.”
Noting that only 12 million babies were born in China in 2020, the fewest newborns since 1961, he also correlated China’s demographic situation to the health of its economy.
“As it is, China’s population growth may reach a tipping point soon where the mortality rate outpaces the birth rate, and the population begins to decline.
“There is only so much governments can do to turnaround structural demographic trends.”
Could Chinese equities surprise investors?
Despite a pessimistic outlook, MLC AM believes that potential returns from Chinese shares may be more promising now than they were when the country was experiencing robust growth.
According to Mr Farmer, small-to-medium sized listed companies are providing an attractive option for investors looking to participate in their growth, as opposed to large state-owned enterprises, which are largely inaccessible to investors.
“Consistent with this, one of the ways we are providing portfolios with exposure to Chinese shares is through investments in companies listed on the Shenzhen Composite Index. This index provides greater access to sectors that, we believe, will benefit from government policy favouring small-to-medium sized enterprises over big companies.”
As the firm has taken in other developed country share markets, Mr Farmer clarified that MLC’s positioning leans towards quality companies, characterised by strong records of profitability and cash flow dependability.