Regulation & Legislation
For many years, it seemed like China couldn’t be beat.
Its world-class manufacturing and logistics base supplied the world with consumer goods ranging from tchotchkes to iPhones. Its swelling middle class flexed imposing economic might, fueling homegrown businesses and enticing pedigreed Western brands. GDP sprinted higher, and in 2016 China swept past Japan as the world’s second-largest economy.
But the past few years have been marred by a succession of economic infirmities. Abrupt regulatory crackdowns blindsided once-exuberant industries. Air leaked from the helium-pitched housing market. China’s critical yet strained relationship with the U.S. grew more tense as the pair clashed over security, commerce and territorial claims.
All of that was capped by the COVID-19 pandemic, with unsparing lockdowns shuttering stores and factories for lengthy periods. The government’s mass testing, extended quarantines and economy-gutting lockdowns sparked mass protests that eventually prompted the government to back off its zero-COVID policy.
Together, these developments cast a pall over China. With the country’s economy at a relative crawl, the risk of government impingement —through either Chinese actions or U.S. sanctions — raised doubts about China’s long-term investment appeal.
However, the economic outlook may be turning a corner in multiple ways.
Measures of business activity are picking up. On the ground, telltale signs of economic activity, from packed restaurants to gridlocked roads and airports, indicate that consumers are out in force since the country’s reopening.
More important, Chinese leaders are once again prioritizing economic growth. President Xi Jinping has made a determined overture to the private sector, signaling that the crackdown on assorted industries is easing and that China is, in effect, open for business. Given Xi’s stated goal of doubling Chinese GDP by 2035, restoring the faith of private enterprise and the investment community is essential.
“I think China is at the beginning of a multiyear upswing,” says Capital Group research director Julie Wang Chou, who has covered China and was based in Hong Kong for 14 years. “It reopened earlier than expected; it’s opening travel and stimulating consumption. I think these are signs that China’s really prioritizing economic recovery.”
China took no chances during the pandemic and instituted some of the world’s most stringent lockdowns. Travel was severely curtailed, and public spaces, including most businesses, were closed for protracted periods. Although the measures helped blunt the spread of COVID-19, they were undeniably painful.
Last year, GDP slumped to 3% — enviable for many developed economies but far below China’s average annual pace over the past few decades. It conspicuously trailed the 5% to 6% rate needed to meet Xi’s economic targets.
“The zero-COVID policy and its attendant lockdowns were disastrous for the Chinese economy,” says Steve Watson, a Capital Group Private Client Services equity portfolio manager, who has been based in Hong Kong for 23 years. “It’s been a really rough ride for China in terms of the pandemic.”
China officially ended its zero-COVID policy in January. Already, there are signs of improvement: Activity in the services sector has strongly increased alongside more anecdotal measures.
“We see it when we talk to the companies, and across all different price points. There has been an acceleration in recovery,” Wang Chou says. “February was better than January; March went even faster than February. You can really feel the energy come back. Our colleagues in China are telling us that traffic is horrendous again — frustrating on the road, but it’s a sign of business activity.”
Consumer spending has lifted the Chinese economy thus far, and the government has many stimulus measures available to it. Compared with the U.S. or Europe, China’s inflation is very low and the labor market is far looser — youth unemployment hit 20% in 2022 — so the country has plenty of slack to fill before growth becomes inflationary.
“I look at China as potentially having the fastest growing economy over the next few years,” Wang Chou adds.
In recent public appearances, Xi has stressed “common prosperity,” in which the fruits of economic development are spread evenly across all strata of society.
“He wants more people to be included in the growth of China,” Watson says. “To that end, the country is pursuing better quality of growth, with less credit expansion. There’s been too much reliance on infrastructure spending and property development.”
That’s been part of the reason for some of China’s recent regulatory gyrations.
“Housing had been in crisis for a few years,” Watson explains, “particularly because of the actions of bad actors that really weren’t focused on building. They were grabbing deposits and only building enough units to keep the ball up in the air.”
The government added certain debt-to-asset requirements for home construction companies. The change was painful, and the damage rippled through the rest of the economy because construction was a significant contributor to growth. But this reflects how China is trying to turn away from the sometimes unstable forms of growth that it once tolerated.
“I think the leadership in China knows they need private business,” Watson says. “However, I think they felt it necessary to send a message about business behavior. I do believe that private enterprise will play a powerful role in China’s future economic growth.”
China is also hoping to leverage one of the elements that many foreign firms have found so attractive: its massive consumer base. Consumption accounts for about half of the Chinese economy, and it was growing about 10% annually before the pandemic. Although that expansion stalled during the lockdowns, it’s starting to pick up.
“We have in China an economy that could potentially compound at 5% a year. That’s coming up the value-add curve,” Wang Chou says. “Industrials have been cyclically depressed for around four years, and I think we’ll see a resurgence in activity. One example: Testing companies, which certify products of all kinds. They’re levered to consumption, especially since the quality of products in China has a history of volatility.”
Similarly, health care is a growing field in China. Given the country’s swelling and rapidly urbanizing population, there are opportunities in hospitals and the other practical, day-to-day ways that people use health care. China’s homegrown pharmaceutical businesses are becoming more sophisticated, with some companies at the forefront of cutting-edge treatments for a variety of ailments.
“Chinese companies are developing new compounds in oncology, for example, but they’re also working around the world establishing a global footprint,” Watson says. “There is real innovation happening there.”
As China has sought to assert itself economically and politically, one of its most important trading partners has increasingly become its biggest rival: the U.S.
The sources of the tension are manifold. Each nation has accused the other of self-dealing, as when the U.S. accused China of manipulating the value of its currency for a competitive trading edge. The U.S. has blacklisted some companies based on national security concerns — Huawei, for example, and now potentially ByteDance, the parent of TikTok. Other issues also contribute, such as Chinese territorial claims that impinge on U.S. partners in the region, notably Taiwan.
“China’s desire for growth has become more politicized,” Watson says. “The phrase 20 years ago was ‘China’s peaceful rise.’ Now it’s more about, ‘We have arrived, we are a world power, and we want to be understood as an important player on the world stage.’ That’s creating friction, with the United States especially but with the West in general. These are tensions that need to be resolved.”
There’s no doubt that this friction could represent real difficulties for U.S. investors. However, there are mitigating factors.
First, while the nature of globalization is undergoing a transformation, the international community is still deeply intertwined. That’s particularly true for the U.S. and China, which last year registered a record $690 billion in trading volume.
“I think of it as a dance. At this point, given how intertwined the economies are, the U.S. and China are mutually reliant,” Wang Chou says. “You have to move with your partner or no one’s going to complete the dance.”
Second, investors can reap some of the benefits of Chinese exposure without necessarily pouring cash into the country itself.
“There’s more than one way to get at this resurgence in Chinese demand,” Wang Chou explains. “There’s directly, through Chinese companies, but also through global companies that would benefit from China’s growth.”
For example, luxury brands are one of the biggest beneficiaries of China’s reopening, she says. Before the pandemic, China made up more than a third of the industry’s global revenue. That dropped during zero-COVID to less than 30%. Reopening — and the potential for “revenge spending,” particularly in light of the significant savings cushions that many Chinese accumulated in the last three years — could be a boon for the industry.
Additionally, China’s push for growth will require a lot of raw materials. It recently expanded iron ore imports, significantly boosting suppliers in Australia and Brazil. An extended period of growth could turn into a multiyear tailwind for those miners.
“China wants to grow. China wants to succeed. It wants to be a player on the world stage,” Watson says. “We need to watch that. We need to watch how it unfolds, who wins and who loses, both in China and outside of China.”
One of the major challenges to investing in China is access. Regulation doesn’t allow foreign companies to work on the mainland in the same way they might in the U.S. or Hong Kong.
“Capital Group had to come up with a solution for doing research there,” Watson says. “And what we landed on was to create a team of what we call China industry specialists. I refer to them as our secret weapon in China research.”
Much like analysts do in other parts of the world, the specialists stay up to date on individual companies and industries. They share their findings with Capital Group portfolio managers and analysts in real-time discussions.
“I don’t know of any other firm that does it this way,” Watson says. “I think it works really well.”
Wang Chou notes: “China is so large now that it cannot be ignored. We would be doing a disservice to our clients if we, out of fear, refused to investigate this market.”