Fund Manager Q&A

Down here in the antipodes, where our own economic fortunes have for many years been closely tied to those of our neighbour to the north, we have seen firsthand how the economic development and increasing prosperity among the Chinese middle class has been reshaping financial markets.

Nowadays, the trade frictions and geopolitical sabre-rattling between the United States and China fill more than their fair share of column inches in the financial press, while the leader of the free world continues to enflame the Twittersphere on a seemingly hourly basis.

But there is far more underlying the ongoing tensions between the two economic behemoths than may be widely understood – and it may have less to do with who is currently playing tit for tat with tariffs in the White House at this point in time, and more to do with Chinese President Xi Xinping's long-term vision for his country and its people.

According to Susan Dietz Henderson, Chief Representative at Capital Strategy Research, the current trade tensions are dynamic and have many moving parts, and it is unclear how the situation will ultimately pan out.

But one thing is certain – they will not distract Xi Xinping from his longer-term ambitions.

"All of the external environment is … dynamic, still playing out. But notwithstanding that backdrop, Xi Jinping still has a vision for China that he's not going to let go of no matter who's in power in the United States," she says.

Among Xi's long-term visionary benchmarks, 2021 is just around the corner, marking the hundredth anniversary of the founding of the Communist Party. Then there are the 2035 and 2050 goals, with 2049 marking the hundredth anniversary of the founding of the People's Republic of China.

"China perceives momentous events in its calendar where … they want to have achieved certain things in terms of their rise in the world and taking back what they see as their rightful place in the world," Dietz Henderson says.

"Xi Jinping wants to make sure that well after he's gone, people will still be talking about him and his legacy for China which, looking back, will be regarded as far more significant than Deng Xiaoping ."

Dispensing with presidential term limits was part of the means to achieving this goal, Dietz Henderson says, with Xi Jinping needing to see his agenda well on its way to being achieved before he could afford to step down.

Even though many pundits thought so, Dietz Henderson says she didn't think Xi Xinping was going to be "president for life" when he first dispensed with term limits, and believes the pressure is growing for him to make sure he's not seen as such.

"But he does need to stay on until he can see that the agenda is moving forward and there is a successor in the wings who will loyally continue what he has set out," she says.

Dietz Henderson says the Trump presidency has complicated Xi's agenda and exposed concerns that other countries have about the nature of the rise of China. Also, Xi's initial introduction of the Belt and Road Initiative and its desire for other countries to utilise Chinese resources under the various loan and infrastructure programmes didn't go down well.

However, the second iteration of the Belt and Road initiative is much more user-friendly.

"They're trying to rethink how they extend loans and bring those partners into China's financial orbit in a more acceptable way. They're being a little bit more friendly to the interests of the countries that are partners in the Belt and Road universe," Dietz Henderson says.

Xi Xinping: A practical leader

Dietz Henderson is of the belief that Xi is not inflexible, but practical. His agenda will be adjusted so that he may achieve his goals for China. And while his restructuring of the Chinese economy into a more qualitative, sophisticated, open system has been distracted by these recent geopolitical developments, it has by no means been stopped in its tracks.

Restructuring the financial sector is one of the key areas of Xi's "great rebalancing". The beginning of Xi's second term, which started towards the end of 2017, saw China try to really tackle this with a very concerted campaign aimed at de-risking the financial system.

"And that meant getting rid of the high levels of debt in the system, whether it was shadow banking or off balance sheet practices that contributed to the debt levels, at all levels of government, and in the banking system itself," Dietz Henderson says.

"The government is also thinking about diversifying how companies source their financing needs. The capital markets are important in that sense. 

"But they have been somewhat distracted by the US-China tensions. And that has had a big impact on the process of that deleveraging and that 'great rebalancing'. I'd say it's not that it's been stopped – it has just been slowed down."

The rise and rise of the middle class

Regardless of these bumps in the road, whether they're around US-China tensions or the future of manufacturing in China, consumer behaviour among the middle class is still a powerful investment theme and doesn't seem to be affected yet by these sorts of uncertainties.

When it comes to sectors of focus for Capital Group, Dietz Henderson says they include, among other areas, all lifestyle considerations, whether it's tourism, health, international travel or education.

With the Chinese middle class thinking about healthcare, healthier food for their children, and living in a clean environment, it means companies in these sorts of industries are going to continue to benefit.

Even the auto sector, which is showing signs of a slowdown in some of China's lower-tier cities, is still an area of interest. But while people are thinking about when they're going to make their first car purchase or even their second car purchase, they're also thinking about the effect on their income of the cost of housing in the lowest tier cities.

"The middle class is much more discerning on those sorts of larger purchases. But the kind of experiential products, whether it's consumer products or tourism, is still going quite healthily," Dietz Henderson says.

Dietz Henderson argues that "premiumising" or upgrading these types of services and products will continue to be a priority among the Chinese middle class.

"And I think that's one of the things that Australia's still attractive for. And with the changing dynamic with the United States, the Chinese will be looking at alternative destinations for education services, even tourism services, and those sorts of things," she says.

One consumer area that is growing among the Chinese middle class, but which many China pundits may not be aware of, is men's skincare and cosmetics – which is growing more rapidly than the skin care industry for women.

"It started with South Korea. But Chinese men are also interested in that as well. Skincare and other 'beauty' products for men are on the rise in China," Dietz Henderson says.

It's all about the fundamentals

With the exception of autos, Capital Group has single-stock exposures to all of the aforementioned sectors in their portfolio. But the manager's process is always about looking at the companies themselves regardless of sector, taking into account the overall sentiment or environment at the macro level.

"It's all about doing fundamental research into the companies, for example in the areas where we understand growth will be, or even where there's consolidation in the sector because of reforms," Dietz Henderson says.

"It's about looking at where the strongest companies will be, and understanding whether or not they will be stronger than when we went in."

Opportunities remain for Aussie commodities

While one of China's priorities is cleaning up inefficient "old industries" and creating a less polluted, more "clean and green" environment for its people, there will still be opportunities for Australian miners given that infrastructure projects are still going to go ahead where they are needed.

Beijing understands that local governments still need to function and that they still need to move forward with their investment plans. Therefore, the central government is coming up with better, more transparent ways of allowing local governments to borrow or raise money. For example, Dietz Henderson says avenues like special purpose raisings can be conducted at a local government level.

"That will enable the investment in infrastructure to continue. In that sense, there are still opportunities for the kinds of commodities that Australia exports to China," she says.

"There's still opportunity there and there's still demand there. It's just that the financing will  be, relatively speaking, increasingly more transparently allocated."

However, Dietz Henderson is quick to reiterate that the super mining cycle of yesteryear is exactly that – a thing of the past.

A financial powerhouse in its own right

As part of its ambitions to a global power, China also understands that it needs to bring its financial system and capital markets further into line with international standards.

China still has some way to go, according to Dietz Henderson, and the US-China tensions have strengthened China's desire to forge a certain level of independence and to become an attractive global finance centre in its own right.

That is part of the motivation for accelerating the reform of China's capital markets. Some examples of this are the MSCI inclusion of increasing numbers of A-shares in its indices, the Hong Kong Stock Connect, the opening up of the bond markets, the London Stock Connect, and the German Stock Connect.

"All of these initiatives are ways of opening up the domestic market to global capital inflows and diversifying the way capital is raised in China away from relaying primarily on bank loans," Dietz Henderson says.

"It also brings global investors into the system. The Chinese view is not only to raise more money, but also to introduce international expectations and operating standards into the Chinese environment as well."

Reaching trade equilibrium

On the question as to whether there will ever be an end to the US-China trade war, Dietz Henderson is sanguine despite her expectation that the conflict will be deeper and more long-lasting than many expect.

"I expect there will be some compromises and they'll come to some kind of agreement, but it will be difficult and will take a few more rounds of negotiation," she says. 

But China's ambitions towards becoming an innovative, technologically advanced country, whether it's in the area of artificial intelligence, biotech, advanced manufacturing, or aeronautics – all of which were outlined in Xi Jinping's China 2025 goals - introduce a set of issues around competition that has a deeper, more strategic complexion.

Dietz Henderson believes that these deeper issues speak to where China will be placed in the world, and where the United States, in some of those industries, will be placed in the future.

Where will these two powers be in the future? And what industries will be affected or will be important in maintaining that competitive edge?

Dietz Henderson says many of the concerns she is hearing today were relevant at the time of China's entry into the World Trade Organisation back in 2001. Many thought its admission would eventually help China develop into a much more open system and that it would open up its economy and industries, but some areas still remain protected today.

"Many of those developments didn't happen at the pace or in the manner that other countries expected," she says.

Regardless of all these complex issues, investors can rest assured that there are many chapters left to be told in the tale of China's ascendancy. 


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