It your eyes are open, China is never dark

The secret lies in the role of the government and the Chinese mindset. With or without a trade deal, there is trade in China.

A week ago, I took a flight to Beijing with Air China. I was pleasantly surprised by the quality of the food and the brand-new airplanes (6.7 years average fleet age versus 10 years in Europe and 20 years in the US).

I was suspicious when the air stewardess insisted that I tried a glass of Chinese ‘Great Wall’ red wine. To my surprise, it was much better than any of the European options on the menu. How can a state-owned airline operation that had negative operating profit just 10-years ago offer a best-in-class fleet, food and wine today?

The secret lies in the role of the government and the Chinese mindset. With or without a trade deal, there is trade in China.

Chinese risk assets have delivered moderate positive performance year-to-date (YTD). Chinese credit is 35bps tighter YTD, performing in line with CEMBI IG index, while Chinese local currency debt is marginally up on the year (+0.16%), slightly lagging the local index (+1.9% YTD).

We maintain our constructive view on risk assets in China regardless of the outcome of trade talks. In fact, we feel that Chinese risk assets offer some of the best risk adjusted returns in the market, even in the event that the trade dispute escalates, as the Chinese government is likely to provide greater stimulus to support domestic demand. Given the recent sell-off in local currency, we like being tactically long the Chinese renminbi.

“What would the most successful multi-national business look like?”, I asked one of our contacts at BASF, the largest German chemical company, during my trip to Beijing. “The people of India, technology of Germany, design of Japan, innovation of the US and definitely the government of China”, he replied.

I share his view. The Chinese government is probably the only government in the world that can provide well measured, targeted stimulus to certain sectors of the economy and see a result in three months’ time.

China also benefits from having high quality data. Joseph Tsai co-founder of Alibaba, when commenting on data comparison between China and the US, replied that it is like comparing fisherman in two separate lakes. With China having the data on over 300 million people, the results of Chinese fisherman are bound to be better than the US ones, given the quality of the fish.

With access to data and government support, Chinese companies are focusing on three key areas – wealth, health and happiness, with particularly emphasis on the domestic market which accounts for over 75% of growth in China.

Wealth; Chinese fixed income assets under management have increased three fold over the last three years, and this is just the beginning. The Chinese savings rate remains high at 47%. Local banks, which store the majority of the populations wealth, are keen to develop the asset management industry further. Foreign inflows are also likely to increase. Investors anticipate an estimated USD 3 trillion of in flows into the Chinese market following the index inclusion of Chinese risk assets over the next few years.

While China’s growth has been the key driver of global growth over the last 12 years, its equity market has delivered flat performance during the same period, while the S&P 500 has doubled. This reflects the poor quality of emerging-market returns. This time around, China is putting more effort into improving quality while slowing the pace of growth.

Health: Did you know that China has 60 million people with diabetes? With these statistics, it doesn’t surprise me that most of the companies see opportunities in pharmaceuticals and health-related business, targeting double-digit growth.

Happiness: The focus on new experiences, travelling and higher-quality service continues and the progress is visible. Take my Air China experience as an example. This was a much more enjoyable experience than I had with the same airline only a year ago.

Then there is the Chinese mindset. Let’s remember that the country’s last downturn was in the early 90s, so many Chinese consumers haven’t lived through a crisis experience. The mindset of ‘opportunity is everywhere’, combined with the fact that China has three-times more millennials than the US, makes the Chinese consumer the trendsetter driving innovation.

Additionally, given the scale and variety among Chinese regions, there is no need to go abroad for opportunities, as one can find emerging markets within China.

The international M&A and expansion trend is slowly being replaced by direct international recruiters for Chinese firms – a cheaper and more effective way to adapt foreign know-how to a Chinese market.

Last, but not least…what does the trade tension between China and the US mean for Chinese growth and investment opportunities?

Whilst in the short-term trade negotiations should keep volatility levels elevated, in the medium-term, I believe domestic growth drivers are more important than the trade dispute. We must acknowledge that we are not in a replay of a Soviet/US cold war scenario, where the two countries did not have any economic ties.

We should also acknowledge that time is on China’s side. Trump has to worry about managing equity markets and his supporter base; Xi Jinping doesn’t.

Trump’s end goals are aligned with investors on a certain level as his tough stance is encouraging Chinese infrastructure growth and SOE reform. Given China’s long-term focus on domestic growth over time, I expect international trade will reduce in importance.

Indeed, I believe the bigger problem for the US in the medium term is an investment bubble, given that investment now accounts for more than 50% of GDP compared to 20% during the last downturn.

For China, we see the bigger problem on the investment side as the process and due diligence bubble, given the lack of experience and high competition for capital. Both are late-cycle phenomena that will likely drive risk-asset performance over the coming years.

As I was sipping my glass of ‘Great Wall’ red wine and reading ‘The Party’ by Richard McGregor, I reflected on the benefits of the Communist Party of China with over 89 million people. Can it achieve economic prosperity in the context of a totalitarian adaptive system? I really ought to start learning Mandarin….

Polina Kurdyavko, Joint Manager of the Strategic Income Fund.

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The opinions expressed are those of BlueBay Asset Management and are subject to market or economic changes. This material is not a recommendation, or intended to be relied upon as a forecast, research of advice.