Are we wrong on China?

I attended a roundtable on China presented by the father and son team, Charles Gave and Louis- Vincent from GaveKal research. Over a lunch of Beef Wellington at a classical Mayfair hotel in London, the GaveKal team put forth that the traditional world trade order which existed since Columbus has ended. China leapfrogged Europe and the US to become the dominant trading and industrial power of the 21st century. No longer the producer of cheap manufacturing, China is now the leader in EVs, solar energy, robotics, and, further ahead, nuclear energy. Years of investments in renewables means that the country has an almost infinite supply of cheap energy, deploying 2/3 of all world’s solar panels. The country also produces a 1/3 of all operational robots in the world. This means that BYD, the leading Chinese car maker, uses 50% of resources compared to Toyota. As a result, BYD’s cheapest EV model, Seagull costs below $10,000. A comparable cheap German EV, Dacia’s Spring retails at $24,950, whilst in the US, the cheapest EV Nissan Leaf costs $30,000.

China now exports more of its goods to other Emerging Markets (EM) countries. Its exports to ASEAN countries in 2023 were 20% higher than those to the US: $912bn vs $665bn. One example of it is ‘Whoosh’, Indonesia’s first high-speed railway completed by a Chinese consortium as part of One Belt One Road initiative in October 2023. Many Western countries would be envious of train infrastructure where rolling stock reaches speeds of 350km/h.

This, argues GaveKal, insulates China from tariff wars should Trump come to power. Increasing its share of trade with EM and denominating this trade in Renminbi allows China to build influence with the emerging middle class in the so-called Global South. To be sure, the West will try to contain China by imposing further tariffs on Chinese goods. Last week’s EU’s tariffs of 18-40% on Chinese EVs underscores this trend. There are ways around it though – several Chinese car makers are building plants within the EU through their local subsidiaries. The US currently bans all Chinese-produced EVs and parts. This is a role reversal of the global order and is a far cry from the 1990s liberal doctrine of globalisation. Europe and the US are busy putting up walls on the movement of goods and labour, electing far right politicians. China, India, UAE and other EM countries are further opening to globalisation and are increasingly looking for opportunities in the east than west.

What about the Chinese Property market?

The Chinese property market is still in an awful state. After years of overinvestments, the housing stock is still falling, and the Real Estate developers are still in trouble. This reflects poorly in the nominal GDP figure, where real estate is a large component.

Yet, GaveKal argues that no other country in the world could endure such a severe balance sheet recession over the last 5-7 years with such relative ‘ease’. Imagine the scenario in the UK where the house prices in mid-sized cities such as Manchester dropped 50% in value in just a few years. What would happen to discretionary spending, jobs, or politicians for that matter? This is what happened in China, yet the country continues to function, people go out and spend money, travel has now slowly recovered to pre-Covid times. The government is finally doing something about zombie Real Estate developers by setting up a fund to bail them out. To be sure, the Real estate deflationary spiral is likely to continue. GaveKal’s argument is that there are other areas in China where one can invest. The fact that GDP of the country is 5% instead of 7% is largely irrelevant. The lack of correlation between GDP and stock market returns has been shown statistically to be valid.

Will the RMB devalue?

This is another hot topic. China bears such as Russell Napier and George Magnus predict that Xi must let the Yuan devalue to create looser conditions in the economy. The logic behind is that China, an interdependent economic power, cannot maintain 3 macro parameters simultaneously – a fixed exchange rate, interest rates and the quantity of money. One must give during periods of sustained stress. These are great points and one can read more about them online: George Magnus’s recent column in the FT and Russell Napier’s blog and podcast.

Counter to that, GaveKal argues that on a kind of-PPP logic the currency is already cheap. They use an interesting example of a 5-star hotel room night index at the Four Seasons in Paris - $2,760 per night, NY - $1105 per night, and Beijing – $225 (!) Similarly, see the example with EVs above where Chinese-made models cost already a 1/3 of US ones. How much lower must they go, is the logic here.

The Chinese stock market is a value trap

China bears such as Napier are very explicit about Chinese stock market been a widow-maker for foreign investors. The recent capital outflows have been huge, and when even locals want to expatriate capital abroad, this is a bearish sign for any investor. In fact, MSCI China has barely produced any excess returns in the last 2 decades. According to Napier, when the political risk is high, as is the case with China according to his view, you risk losing all your investments. Yes, the stock market is cheap, but it’s cheap for a reason.

GaveKal’s response is nuanced. Their main thesis on China is that it is industrial empire in the making. It will be an industrial powerhouse for the rest of the world for the next generations. Their core belief is that Europe and the US will try to engineer their own industrialisation. A great idea, in theory – especially popular with the voters- but a difficult one to implement. As an example, their cite US’s much vaunted IRA bill which so far produced fewer tangible benefits than originally purported, but at a great cost to the US treasury. The already straining fiscal imbalances in OECD world, together with higher costs of labour, more stringent environmental regulation and political divides – present large execution risks for an industrialisation policy in the west.

A far more interesting indicator for China’s stock market is the Yen. Japan remains China’s other industrial rival in the East. If the era of quantitative easing comes to an end and the Yen strengthens after a 40% depreciation in the last few years, it will light fire on China’s competitiveness and its export muscle.

Final words

Gavekal’s somewhat contrarian view on China is at odds with the current sentiment in the west. Eyeing China on par with the other ‘bad actors’ like Russia and only focusing on Taiwan as a locus of geopolitical tension, ignores the industrial capacity story that China achieved in the last decade.

A lot of the misunderstanding is explained by the fact that not many westerns travelled to China in the last 4 years. The negative press surrounding the botched Covid reopening, the doom and gloom of its property market obfuscates a more nuanced story. According to GaveKal, China is entering a stage of Deflationary Boom, a ‘goldilocks’ period where asset prices go up along with economic growth. Once this happens, investors would look back when Chinese tech stocks trading at 10x multiples, and regret not pulling the trigger today.

16th of June 2024

Disclaimer:

The information provided in this article is for educational and informational purposes only. It does not constitute an offer to solicit any securities, nor is it intended as financial advice. The views expressed herein are strictly those of the author and do not necessarily reflect the opinions or positions of the company. Readers should consult with a qualified financial advisor before making any investment decisions. The company disclaims any responsibility for actions taken based on the content of this article.