With the US Federal Reserve signalling that it is likely to start winding down its asset purchase programme and higher interest rates appear on the horizon, the world is moving from an era of accommodative policies and easy financial conditions towards a new and potentially challenging environment. However, the US is not the only driver of global events; China is playing an increasingly vital role in shaping our future.
12/10/2021
Against this backdrop, Marty Dropkin, Fidelity's Head of Asian Fixed Income, and Anna Stupnytska, Fidelity’s Global Macro Economist, appeared in a recent edition of our Rich Pickings podcast when they explored recent developments in China and how these are affecting investor sentiment.
It’s well established that China wants to move towards a more sustainable economy. “As the country attempts to reduce some of the leverage in its system and adopt a more domestically driven approach, there are signs that rest of the world may not have caught up with the longer-term implications of the move for other markets,” says Dropkin.
“This desire to tackle excessive borrowing is most starkly reflected in recent events surrounding China’s largest property developer Evergrande,” continues Dropkin. The company owed something in the region of US$300 billion, and investors have focused on whether policymakers will provide a bailout. From the government’s viewpoint, this is an opportune moment to show that the market’s long-standing belief that troubled companies will automatically be bailed out may no longer hold true. Indeed, the government is determined to explore ways of fixing corporate problems that don’t involve large sums of emergency cash.
Treading a fine line
“Of course, property is an incredibly important segment, so the government is aware that it must also tread a fine line and not be too hands off,” notes Stupnytska. This is mainly because problems in the property sector could spill over into the broader economy and hamper the longer-term drive towards broad-based ‘common prosperity’ in areas such as healthcare and education.
The summer months also saw other stark headlines concerning heightened regulatory action focused on specific sectors like online education. “I think many people were just becoming more comfortable with China, so this scared everybody a little,” suggests Dropkin. “And I think that investors will, perhaps, pause for breath.” However, he also points out that when the dust settles, there will still be some attractive investment opportunities, particularly in China’s High Yield and government bonds.
“If you look at the 10-Year Chinese government issue versus the US Treasury equivalent, then you're still picking up about 135 basis points.1This may be slightly tighter than it was earlier in 2021, but it’s still a good opportunity,” adds Dropkin.
Common prosperity
Short-term upheaval, although unsettling, doesn’t last forever. China’s government knows this, and that’s why their actions today are taken with the future in mind. As Andrew McCaffery, Global Chief Investment Officer, Asset Management at Fidelity International, recently noted, “Domestic resilience and long-term economic development are what really matter because common prosperity means growing the middle class and increasing per-capita incomes. This is something that investors need to grasp in order to look through near-term volatility.”
Neighbourhood watch
From a growth perspective, Stupnytska recognises that China’s GDP will be lower, “But its composition is going to be different, more driven by consumption and less by investment and exports. That’s a balance the government has been trying to achieve.” She also touches on the country’s near neighbours that are often first to feel the impact of any economic or social developments. “If we look at manufacturing, then some Asian countries will be beneficiaries as production facilities are relocated to markets where labour is potentially cheaper,” says Stupnytska. “In turn, this will also lead to a meaningful restructuring of global supply chains.”
Sustainable change
Another theme that will be vital to China’s future progress is climate change and energy transition. The panel was keen to point out that the whole process will not end within a few years. This will be a generational movement, and it could take 40–50 years before the country’s energy mix truly alters. From an investment standpoint, this multi-decade period means that analysts shouldn’t necessarily dedicate all their time and energy to the renewables space. They should still pay attention to traditional infrastructure, which isn’t going to disappear suddenly. Again this ties back to fully understanding what will happen in China over an extended time frame.
In tandem with energy transition sits the issue of carbon pricing. “I think if China is to achieve net zero carbon emissions by 2060, then we need to see much higher carbon prices,” states Stupnytska. “So we must look more closely at companies that are developing carbon-capture technologies, as this is key to scalable and effective carbon capture and removal.”
The key takeaway from the panel discussion was that nerves should be held and an eye kept on the bigger picture in China. Headlines may be alarming, but by this time tomorrow, they will be yesterday’s news – investing shouldn’t be viewed in the same impromptu manner.
1As at 30 September 2021.
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