China, the world’s second-largest economy, is stumbling. While the global economy struggles through the pandemic, this economic powerhouse is facing problems beyond COVID-19.
Gross domestic product (GDP) slumped to 4.9 per cent last quarter from a year earlier. That’s a big drop from 7.9 per cent GDP growth in the previous quarter as the country faces a housing slump, electricity shortages and thorny relations with its largest trading partner, the United States.
Furthermore, Beijing has signalled that growth will continue to slow in the next few months, a wild departure from the double-digit GDP growth over much of the past three decades.
As a result, the Chinese equities popular in many Canadian investment portfolios – held either directly or in mutual funds and exchange-traded funds – have floundered behind other major indexes.
“As the country gets wealthier, the growth will slow down,” says Evelyn Huang, director of global equities at Toronto-based Black Creek Investment Management Inc. She has been investing in China for the past two decades and says the slowdown was long overdue.
“Our approach has always been patience. We need to get through the current fog and think about what it means in the long term,” she says.
That patience could be wearing thin for many investors as concern mounts over whether ongoing debt problems with Chinese property development giant Evergrande Group could spill over into the broader markets. Ms. Huang says she believes the Chinese government has the means to contain the Evergrande fallout, whether it survives or not.
“Evergrande is nothing new to us. We know the government has put in place more strict funding requirements to try to deleverage the public development sector,” she says, adding that China’s authoritarian sway not only reduces systemic market risk but can also provide insight into emerging investment opportunities. Her focus is currently on government measures to deal with an aging population and rising wealth inequality.
“We have always had the view that when you invest in [Chinese] companies, you need to align yourself with government policy priorities … given that the decision-making is not very transparent,” she says.
Ms. Huang says she expects growth to continue at a slower pace as Beijing attempts to strike a balance between what it calls “common prosperity” and incentivizing the private sector to invest and innovate.
“It’s not just about making money and being profitable but you have to contribute to better the society. You can gouge your customers but the government certainly doesn’t view that as a sustainable business practice,” she says.
As an example, one of Black Creek’s core holdings is Alibaba Group Holding Ltd. BABA-N. As a bellwether, she considers growth for the online retail giant to come at a slower pace along with the broader economy but expects the government to fully support the company because its advancements in technology contributes to the common prosperity.
“Alibaba serves as a platform for small merchants and farmers to sell their products worldwide. It’s a bridge for those smaller merchants to be able to compete on a bigger scale,” she says.
Other examples of Chinese companies she believes have the potential to overcome the short-term challenges facing China are biopharmaceutical manufacturer WuXi Biologics Inc. WXIBF, gaming and entertainment provider Galaxy Entertainment Group Ltd. GXYYY, and sports product manufacturer Anta Sports Products Ltd. ANPDF.
“The common traits of those companies are that they’re market leaders. They keep investing to widen their competitive advantage even through difficult times and there’s the strong underpinning of fast industry growth,” she says.
Despite China’s short-term problems, Ms. Huang says an economy of such magnitude belongs in any long-term, diversified portfolio and the current slump in Chinese equities could be a good time for Canadians investing for retirement to pick up some bargains.
“China still offers better growth prospects as the country still has room to catch up in terms of overall GDP levels,” she says.
Darren Sissons, portfolio manager at Campbell Lee & Ross Investment Management Inc. in Toronto, agrees with Ms. Huang and says many investors might be short-sighted when it comes to China.
“One thing is for sure: China is going to continue to rise, and countries and businesses need to be cognizant of that,” he says.
Mr. Sissons brushes off concerns from market pundits that Evergrande’s financial troubles will spread.
“The global macro guys are saying Evergrande is going to blow up the world. That’s nonsense,” he says. “From a practical point of view, if the Chinese central bank wanted to take it out, it could do it with cash … it could just buy the bonds.”
Mr. Sissons had a ringside view of China while working in Taiwan during the 1990s and has focused on giving Canadian clients exposure not only to Chinese equities but global companies benefiting from its vast economy and global influence.
“Every global multinational has 10 to 20 per cent of its business in China,” he says.
Normally, he invests in large Chinese companies or companies that do business in China through Hong Kong. One of his offbeat holdings with a view toward the westernization of China is Hengan International Group Co. Ltd. HEGIF, which produces tissues and sanitary napkins.
“The market doesn’t like it because it’s not sexy, but you will get rich gradually selling toilet paper,” he says.
Mr. Sissons also invests in China through foreign exchanges in companies such as Finland-based elevator multinational Kone Oyj KNYJY, which serves 40 per cent of China’s elevator market, and Novo-Nordisk A/S of Denmark NONOF, a global leader in treating diabetes.
Fundamentals aside, Mr. Sissons says the biggest threat to China may come from an authoritarian government out of touch with the rest of the world. He uses China’s recent detainment of two Canadian nationals, Michael Kovrig and Michael Spavor, in a diplomatic dispute with the U.S. as an example of its heavy-handed approach to foreign relations.
“The approach they’re generally taking is a bully approach. They grabbed two Canadians just to prove a point,” he says. “Its foreign policy is immature”
Mr. Sissons is confident, though, that China will eventually adapt.
“Over time, they will get more sophisticated, and as more countries collectively push back, they will have to change their strategy,” he says.