Are Chinese Shares A Unique Opportunity? Part II

International | Feb 10 2021

Chinese government expenditure plans will create tailwinds for certain industries and sectors, while at the same time providing vital clues for share investors.

-Details of the Chinese five year plan
-Innovation, urbanisation and equity finance to boost growth
-How to invest in the China A market

By Mark Woodruff

The first article (see link below) examined the implications for investors of ongoing trade tensions between the US and China.

In this article we look at where Chinese government policymakers are directing the economy to identify those industries, sectors and companies that should benefit from tailwinds.

China is looking to develop “Three New Economies” which includes new industry, new types of businesses and new business models. For example, a digital-based economy and new energy vehicles (NEV) are being strongly promoted.

In reaction to the pandemic, the Chinese government launched government fiscal programs of unprecedented magnitude which are set to benefit some industries disproportionately over others in the year ahead.

In addition, the government has signalled a major strategic shift in China’s approach to economic and social development, via the soon-to-be-announced Five Year Plan (FYP) for 2021-2025. 

We will begin by looking at the fifth plenum of the Chinese Communist Party’s 19th National congress, which concluded on 30 October 2020. This meeting laid out the policy blueprint for the FYP and will provide vital clues for investors in 2021 and beyond.

Fifth plenum – big picture

China will become a ‘’mid-tier developed country’’ by 2035, believes President Xi Jinping. GDP per capita is expected to double to US$20,000 per person. Strategists at ANZ Bank calculate this would place its citizens on par with those of either Greece or Portugal today.

However, there are a range of objectives beyond GDP that include tech-sufficiency, social equality and going green. The President advocates prosperity sharing, not only within China (expansion of the middle class), but also with other countries. One example of the latter is the Belt and Road Initiative (BRI). It appears to ANZ, Xi wants to market a business model for “the community with a shared future for humankind”.

After China opened up in 1980, the country’s labour force soon became a tailwind to produce and manufacture cheap goods for the world. Now the population profile is at risk of becoming an anchor as it rapidly becomes older.

Solutions to this problem are needed. The government is looking to innovation as a means to offset the shrinking working age population. Urbanisation also can also address the other demographic challenge of disparity between rural and urban incomes. By addressing income disparity, urbanisation will not only improve income but also increase consumption.

Another area of development is the new energy revolution, which involves a combination of three long-term objectives. These are decarbonisation, industrial upgrades and energy safety.

Urbanisation

China’s current urbanisation rate is only 60.6%, which is -15% lower than the level of Japan in 1980. If China can increase that rate by 1% each year, it means an additional 210 million people will live in urban areas. This would have the desired effect of doubling average income per capita by 2035 and by extension generating the largest pool of consumers in the world.

The income disadvantage of rural living was clear in 2019, when the disposable income per capita of rural households represented only 37.8% of the income of urban households.

Between 2006 and 2018, the number of Chinese cities of a million people or more grew from 117 to 161, while those with four million people rose from 13 to 20. While the number and size of cities are growing, it’s also necessary to link them up to each other.

China will continue to invest in its railway network to support its city clustering plans. It’s expected high speed railway coverage will double to 70,000 km by 2035 and by that year all cities with a population of more than 200,000 will have rail access. In addition, all cities with a population of 500,000 will have access to high-speed rail.

The ANZ calculates this implies 10% of China’s GDP will be invested in the railway sector through to 2035 (regardless of corresponding technology investment).

Land reforms are also expected to fundamentally change the property landscape. Property investment could grow moderately, as the government would like to develop the rental market and build more affordable homes. Under the upcoming FYP, many cities will be allowed the use of collective construction land to build rental apartments and link the land supply with migrant workers.

ANZ notes that China’s economic rebalancing is often interpreted as a shift towards a consumption and service-led economy, with manufacturing and investment declining. However, when one takes into account urbanisation and what is needed to achieve it, neither infrastructure investment nor China’s factories are expected to decline.

In the bank’s opinion, the manufacturing sector is the root of the real economy, especially in the high value-added segment. A stable manufacturing sector is expected to prevent economic growth from sliding dramatically, especially when the sector’s productivity is lifted. 

Indeed, if the sector reaches around 5.5% year-on-year growth, a pace similar to that of 2019, ANZ expects the contribution to GDP will outpace that of the non-manufacturing sector by 2035.

Innovation

Lifting productivity is another way to offset the negative impact from a diminishing working age population. According to IMF research, a 1% increase in the digitisation of China’s economy brings about a 0.3% increase in GDP growth, with a two-year lag. 

Digitisation brings lower transaction costs, enhanced production efficiency and decreased information asymmetry. The latter is where one party to an economic transaction possesses materially greater knowledge than the other (e.g. an actuary in the health insurance industry and the insured).

According to the professional services company Accenture, artificial intelligence is an example of digitisation that could add as much as 1.6% to economic growth by 2035.

However, innovation is easier said than done. As China pushes for ‘socialist modernisation’, the conditions needed for rapid growth will challenge the existing institutional structure. These conditions include protection of property rights and a rule of law that effectively limits the power of government. 

Additionally an independent judiciary to enforce the rights stated in the nation’s Constitution and market forces are all essential for innovation. It will be a real test for President Xi’s ambitions as he pushes for ‘socialist modernisation’, cautions ANZ.

New Energy Revolution

Policymakers have set a goal of 95% energy self-sufficiency by 2050 (as compared to 81.5% in 2019), which means the country will be able to supply its own domestic energy needs.

As a by-product, the development of renewables will help China reduce its reliance on imported fossil energy. This is a positive for energy safety, which is a growing security concern within the country. 

Natural gas will be the key transition fuel over the next five to ten years and a national pipeline company has been established for gas distribution.

To achieve climate goals, China is expected to meet the bulk of its new energy demand with renewables during the FYP period of 2021-2025. Investment in renewables capacity will double. The supply-side will benefit from renewable energy capacity investment, while electrification will accelerate technological progress in manufacturing. The economy as a whole will also benefit from the cost efficiency of new energy.

It’s estimated the investment to achieve carbon neutrality is US$15 trillion over the next three to four decades. According to Longlead Capital Partners, this represents an enormous opportunity for companies involved in the solar, wind, hydro, hydrogen and electric mobility industries. For example, the world’s largest supplier of glass fibre for wind turbine blades is the mainland Chinese company, China Jushi.

According to Longlead, the global electric vehicle (EV) penetration rate is expected to rapidly accelerate in 2021 as government initiatives and new car company model launches ramp up simultaneously. This transition to EV mobility is happening ahead of prior expectations as costs come down and decarbonisation is re-prioritised.

China remains the largest market for EVs, accounting for approximately 50% of global EV share. China still sold 1.21 million units of EVs in 2019, almost 4 times larger than what was sold in the US, despite cutting the subsidies on electric cars. This local demand has positioned Chinese and other Pan-Asian auto parts companies as critical suppliers of EVs and components globally, which puts them in box seat to benefit from the rapid transition.

Another investment angle is provided by UBS. The investment bank recently estimated that EV battery demand will grow ten-fold by 2025.

5G telecommunications

China has announced new initiatives in 2020 to accelerate the rollout and adoption of 5G telecommunications networks. They are seen as a key enabler of productivity, and an industry that has large scale investment opportunities that will support an economic rebound.

This accelerated rollout will benefit mobile handsets, antennas and Internet of Things (IoT) devices. Other beneficiaries include telecommunications construction and consultancies, servers and data centres.

On the back of a new handset upgrade cycle, Longlead expects an inflection point for 5G telecommunications in 2021, with Asia being the main supply chain for the key components. These include cameras, antennas, modems, memory, printed circuit boards and accessories.

It is not only about consumer mobile telecommunications, but also the industrial internet of things, including smart home devices. The extensive reach of 5G is now creating an ecosystem for new IoT players in the Pan-Asia region. This extends past technology companies to even plastic injection moulding and packaging materials.


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