China's Green Shoots

From a valuation standpoint, China is the most attractive market in the world. From a climate standpoint, it has the most available names in the ScopeFour investment universe, with climate solutions that offer strong emissions reduction potential. From a geopolitical standpoint, it is also one of the riskiest and most controversial. Due to these geopolitical clouds and the recent trend of deglobalization, foreign capital flows have been very negative over the last few years and has resulted in significant underperformance of Chinese equities vs. global market peers.

?Geopolitically, we would expect the US and China to be in a perpetual state of conflict over the near to medium term, with order of magnitude depending on the hawkishness of the U.S. administration in charge. But for global inflation to cool down, China’s cheap manufacturing capacity has to be part of the solution. For the world to achieve its net zero goals, China also has to be part of the solution. For example, more solar capacity was added in China last year than the rest of the world combined.

?China is a great market for active stock-picking, but an investor must be nimble and experienced given these macro headwinds. Their current market environment reminds us of the Japanese equity markets in the 1990s after their property bubble burst, where significant returns were generated by bottom-up active management.

?We believe patient execution within a China allocation will be rewarded over a 3-5 year holding period.

?We are treading cautiously and watching four potential headwinds:

• Overall GDP may come in lower than expected for 2024
• Depending on who wins the US election, there is potential for increased tariffs
• Uncertainty around Taiwan will not be resolved anytime soon
• China’s indebted property market will have to be written down

On the flip side, positive catalysts to look for in 2024 include government intervention to backstop the property market, which we believe could trigger an equity market rally. We are also seeing early signs of foreign capital returning to China, as its equity markets have been outperforming in recent months.

According to the IMF, China generated 28% of total global savings in 2023. The EU and the US are roughly 33% combined, which means the ability of Chinese officials to unlock this excess savings and spur consumption will be a key determinant on the future direction of global interest rates. In a speech given earlier this year, President Xi highlighted the need for a new model for economic development based on innovation, unleashing “new productive forces” for China’s economy. This phrase has now appeared multiple times in state newspapers and official government meetings, and includes a mandate to make Chinese industries “higher-end, smarter, and greener.”? This is an area where specifically climate-oriented investors should take note.