Pelosi in Taiwan: Should you worry about investing in China?
Tensions between the US and China have risen rapidly this week after US House of Representatives Speaker Nancy Pelosi landed in Taiwan on a state visit, unsanctioned by President Joe Biden. This is the first by such a senior US official in 25 years.
The Chinese government warned there would be “serious consequences” before Pelosi made the trip and has since carried out a series of military exercises in Taiwanese waters, reviving fears that China could annex Taiwan by force.
Taiwanese President Tsai Ing-wen tweeted that Pelosi’s visit “reflects strong US congressional support for bilateral ties – it also sends a message to the world that democracies stand together in the face of common challenges”. China is furious, considering Taiwan to be within Chinese territory, and has announced six large exclusion zones around the island state starting from tomorrow, 4 August, lasting four days.
Investors with exposure to both China and Taiwan are now seriously asking whether this latest bout of uncertainty is cause for concern.
James Yardley, senior research analyst at FundCalibre, said: “Markets are a bit jittery generally and they did react a little yesterday. But the China and Taiwan situation has been bubbling away for years, decades even.
“The current move seems to be the US doing a little bit of sabre rattling of its own and testing China’s resolve, which I suspect they believe has been weakened recently following the Russia/Ukraine invasion.”
Yardley said China may “think twice about an invasion” having seen the “difficulties Russia has run into”.
He added: “As such, the US has been emboldened to step up its defence offering to the island. The meeting wasn’t endorsed by Biden, meaning that diplomatically, there is ‘plausable deniability’, but it still creates headline news for the Democrats, which is useful for them coming up to mid-terms. They are considerably behind in the polls and struggling with their domestic agenda.
“It is interesting to note that Pelosi – a high ranking official with limited election exposure – is the one who has gone,” he said. “If there were to be any invasion planned by the Chinese, we would know about it many weeks, if not months, in advance. There are no indications any designs are being put into action quite yet. So for now it’s just wait and see.”
Until this week’s political upset, experts had been suggesting that Chinese equities still offer value for UK investors. Now the outlook is far less clear: should you be committing cash amid so much uncertainty? We take a look.
Political tensions aside, what’s going on in China’s economy?
China had a bad start to the year, with markets dropping to a low in April as the country’s strict zero-Covid policy weighed on its growth prospects.
On the back of its crackdown on technology companies, a property bubble and signs of an increasingly restrictive regulatory regime, investors were spooked.
In July China reported GDP growth of just 0.4% in the second quarter compared with the same period in 2021. Retail sales dipped 0.7% in the first half before beginning to recover in June. The country’s official 2022 annual growth target of 5.5%, less than last year’s 8.1%, could be optimistic.
Indeed, the latest National Bureau of Statistics of China manufacturing purchasing managers’ index reported on Monday 1 August unexpectedly fell to 49.0 in July, from 50.2 in the previous month and missing market forecasts of 50.4.
Sophie Lund-Yates, lead equity analyst at Hargreaves Lansdown, said: “There was a very mixed bag hidden within the results, with core trends showing the negative effect of new lockdowns in key cities and general concerns over the global economy, following sharp monetary tightening efforts. Output, new orders, buying levels and export orders all shrank. This latest data set does very little to offset concerns around darkening global economic output, especially when put together with a further easing of sentiment.”
While the rest of the world is clamping down on cheap money, denting global demand for Chinese exports, China is bucking the global trend of higher inflation and tightening monetary policy. Its own inflation rate is low enough that its central bank has cut interest rates twice this year, bringing mortgage rates down and shoring up its ailing property sector.
Markets had picked up since May. In June the MSCI China A Onshore index and MSCI China delivered 10.1% and 6.6% respectively while the MSCI World fell by -8.63%, marking an outperformance by the Chinese markets of over 15% within a single month.
Global investment firm RisCura’s head of research, Faisal Rafi, recently said he expected this trend to continue.
“While China has its own unique risks, it is at a very different phase of the economic cycle,” he said.
“It does not face the same stagflation risks as developed markets, the economy is recovering from a cyclical low, stimulus is coming through, and valuations are significantly lower than developed markets.”
Fidelity investment writer Graham Smith, said: “China’s stock market has given investors a rocky ride so far this year but shares have staged a significant recovery since May on hopes the government will engineer a period of faster growth. That’s got investors interested again.”
Smith said there are signs that China’s government is stepping up its stimulus, pointing to a significant uplift in infrastructure investment which shot up by 7.1% in the first half of the year.
“Importantly, at a time when the rest of the world is eying higher inflation and interest rates, there is scope for Beijing to cut a rather different cloth, with looser lending practices and increased local government spending,” he said.
But he warned: “Whatever happens, it won’t all be plain sailing. There are risks to adding stimulus to the economy at this point. It could dilute attempts to reduce over-borrowing in the property sector, the reverse of what is needed. Also, direct cuts to domestic interest rates could risk triggering capital outflows, especially with US interest rates moving higher.
“Even so, government clout and a pent-up demand among consumers suggest now could be the wrong time to bet against a Chinese recovery. Signs that a clampdown on tech companies may have run its course are another reason for encouragement.”
Is it time to buy into China?
The MSCI China Index is typically trading at around 12 times the earnings companies are expected to make over the coming year, compared to about 16 times for North America.
Smith said: “Judging by the market’s progress over the past couple of months, some investors have already sensed the opportunity.”
Rafi said the recent government stimulus would likely have a “dramatic impact” on economic activity, prompting a further rebound, but he warned markets would remain very volatile.
Justin Thomson, head of international equity at T. Rowe Price, said investors with a long-term view were optimistic.
“Caution over investing in China is higher than it has been in decades – and not without reason. An uncertain regulatory environment, concerns over the country’s strict Covid-19 regulations, and growing geopolitical tensions have left many foreign investors feeling jittery about putting money into the country.
“However, despite China’s apparent lurch toward authoritarianism, the authorities will not allow the ‘common prosperity’ programme to derail the economy.”
He believes China in five years’ time should be “more investor friendly” than it is today.
Countering that perspective, Pimco’s China economist Carol Liao and US economist Allison Boxer wrote in a market note recently: “In the longer-term, we see rising risks of deglobalisation and more fragmented capital markets. China’s role in the global supply chain could diminish over time, as the US government seeks to ease America’s reliance on China’s massive manufacturing base for goods, spare parts, and materials of all kinds.
“These trends may augment economic inefficiencies and increase inflationary pressures in the years to come, prompting many investors to focus on building resilience in portfolios.”
What are the risks of investing in China?
James Yardley, senior research analyst at FundCalibre, said the big negatives in China are its property bubble, government intervention and political tensions.
“For the past few decades the government has been happy for companies to make large profits,” he said. “The recent crackdown on technology and education, however, means some investors fear this is now over and that companies will be expected to spend their profits on things which are not in shareholders’ interests.”
He is also very concerned about political tensions between the US and China, particularly in respect of Taiwan.
“By far the bigger issue is TSMC, based in Taiwan, which makes the most advanced microchips in the world,” he said.
“TSMC is now arguably the most strategic asset on the globe. Chips are used from everything from iPhones, to AI, to ICBM guidance systems. US giant Intel has now fallen well behind TSMC. Only Samsung can really offer some competition.
“The West does not want TSMC to fall into the hands of the Chinese. From the Chinese perspective they have this incredibly powerful strategic asset right on their doorstep which they can’t access. This all leads to massive tension.”
Opportunities to invest in China
According to Thomson, compelling opportunities exist in areas such as electric vehicles, renewable energy, and mature sectors undergoing consolidation.
Jacob Mitchell, founder and chief investment officer at Antipodes Partners, warns that with the property and technology sectors going through significant regulatory changes, near-term performance was uncertain.
But he added: “If you take a medium or longer-term approach, the opportunities in China have not changed. Our aim is to find resilient businesses trading at attractive valuations. When you factor in the higher discount rates that are applied to Chinese companies, simply because they are in China, a lot are still attractive.”
James Penny, UK chief investment officer at TAM Asset Management, said China’s economy and its burgeoning middle class look set to take an increased share of the global economic stage.
“Markets should positively reflect this over the next few decades,” he said. “One thing remains certain, though, investing in China requires a tacit acceptance that turbulence will likely continue.
“How comfortable investors are with volatility will dictate how much of a portfolio can be allocated to China relative to more established markets.”
FundCalibre currently likes a number of China funds, including FSSA All China, Invesco China Equity, Allianz A Shares and JPM China Growth & Income Trust.