The China of 2019 is a different country than it was in 2009, when AllianceBernstein first began investing in Chinese onshore equities, also known as A-shares. Consumers, rather than investment, increasingly drive China’s economic growth, while its domestic stock market has opened to foreign investors and the country’s fundamental relationship with the United States has changed irreversibly.
What hasn’t changed? The composition of the market’s investor base. Though China’s stock market is maturing, retail investors still dominate, creating unique opportunities for experienced investors.
On the 10th anniversary of our entry into the A-share market, we reflect on what the following four trends could mean for China in 2029.
1. Different Economy, Different Definitions of a “Promising Company”
China’s breakneck economic growth has slowed—nominal GDP increased 18% in 2008 and less than 9% in 2018. That’s partly because, at US$12 trillion, the economy is too big to keep expanding so fast. But it’s also because the economy is maturing.
In 2009, growth depended on building infrastructure and factories that churned out goods for export, often on behalf of European or American companies. The best-performing companies were those that expanded fastest—period. But as the labor supply shrinks and wages rise, China is no longer the world’s low-cost factory. Chinese firms are increasingly outsourcing their own manufacturing to lower-cost countries such as Vietnam.
The manufacturing, materials and infrastructure companies that are thriving now are those investing in technology and making high-quality, advanced products that rival those of established foreign competitors. Machinery companies such as Sany Heavy, for example, are successfully going head-to-head with rivals in Japan and the US to tap new markets in the Middle East and Africa. Automation is widespread.
Meanwhile, Chinese consumers have gotten richer. GDP per capita has more than doubled, from about US$3,800 in 2009 to about US$9,600 in 2018, according to the World Bank. Small wonder either that consumer spending contributed more than 5 percentage points of China’s 6.5% real GDP growth in 2018, or that education, sportswear, technology and healthcare companies that cater to the growing middle class are the new up-and-comers.
It’s important to remember, however, that Chinese consumers are diverse. Young consumers spend more freely than their older counterparts. Middle-class consumers, particularly in coastal cities, have embraced a new generation of domestic brands, but the Chinese working class is more likely to spend its growing income on newly affordable foreign brands. It takes a lot of in-country experience to decipher such nuances and decide which consumer-oriented companies have staying power.
2. A-Shares, Meet World. World, Meet A-Shares.
Most financial firms are underweight A-shares because they’ve historically been difficult to invest in. In 2009, when we entered the market, foreign investors had to meet strict requirements and overcome many bureaucratic hurdles to register for both a license under the Qualified Foreign Institutional Investor (QFII) program and an investment quota.
Access became easier with the 2014 launch of Stock Connect, which allowed foreign investors to buy and sell A-shares through Hong Kong without a license or quota. Another major leap occurred in 2017, when MSCI announced that it planned to include A-shares in its Emerging Markets Index. It followed through in May 2018 and plans to continue increasing China’s representation.
Now that A-shares are part of the benchmark index, many foreign investors are playing catch-up. MSCI estimates that A-shares could see up to US$80 billion in new foreign inflows in 2019 alone, while cumulative net flows from Hong Kong to Shenzhen and Shanghai since the launch of Stock Connect reached US$96 billion on May 31.
As more foreign and institutional capital flows into A-shares, financial products such as index futures, swaps and other derivative instruments are likely to follow, creating new opportunities.
3. Mom and Pop Are Still in Charge
For now, however, retail investors still comprise 82% of the portion of the A-share market’s trading volume. That means the A-share market is, and will remain for some time, highly volatile and riddled with inefficiencies from which experienced China investors can benefit.
One example: In 2016, after Donald Trump was elected president of the United States, shares in companies with names similar to Trump’s translated name, Te Lang Pu, skyrocketed. Yet nothing fundamental about their business models or cash flows had changed overnight. Mispricing episodes like this are common and create opportunities for savvy investors with a long-term approach.
4. A New Relationship with the US
No discussion of changes in China would be complete without mentioning geopolitics. In 2009, China was firmly established at the heart of global supply chains, particularly when it came to assembling US technology. In 2019, China is experiencing a backlash of sorts from decades of US outsourcing, which contributed to the rise of populism. US tariffs and increasing scrutiny of Chinese tech companies have fundamentally changed the relationship between the two countries, probably for good.
No matter what macroeconomic or geopolitical headwinds are buffeting the Chinese economy, however, shelter is usually available in the enormous A-share market for investors with strong research capabilities. Despite the trade war, for example, pork producers are poised to benefit from a swine flu–related shortage that is expected to drive up prices.
Onward to 2029
When viewed through a long-term lens, we think China’s onshore equity markets offer investors an uncommon opportunity. A-shares are likely to benefit as foreign inflows boost stock prices, as well as from the promise of reforms that create a better-functioning market and unprecedented opportunities for investors with strong fundamental research capabilities.
While the way China has moved up the value chain and raised the living standards of its people is familiar to global investors who watched Taiwan and South Korea accomplish the same thing in the 1990s, its journey forward will be unique. The government still plays a prominent role in every aspect of the world’s second-largest economy, and China’s increasingly high-profile role on the geopolitical stage will affect Chinese companies. Choosing a manager that has learned from the changes of the past is essential to success in the future.
