As China continues to dominate headlines, we caught up with our CEO & co-CIO Stephen Jen to ask what China's prospects are for economic growth, geopolitics and his outlook for Chinese assets.
This collection of videos answers three simple questions:
- What are your expectations for the Chinese economy?
- What are your thoughts on the geopolitics of the region?
- What is your outlook for Chinese assets?
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What are your expectations for the Chinese economy?
China had declared a target for the for the economy of 5.5% for this calendar year. They're obviously not going to achieve that. Last year we saw 8.1% growth, and so far this year we're seeing only 2.5% growth. So if China manages to grow by five and a half percent in the second half, the average for the year will only be 4% and that's achievable.
I think three and a half, 4% for the year is achievable. One technical foot note I should highlight for the audience, is that the world's convention for reporting GDP, quarterly GDP growth, is sequential. Quarter on quarter. And sometimes they annualize numbers, sometimes they don't. But in China they never report sequential, quarterly numbers. They report year numbers. So 2.5% for the first half of this year, actually means outright contraction on a sequential basis.
There was actually a outright contraction in the first half of this year much smaller than what we saw in early 2020 on the onset of the pandemic.
So are we worried? Or should we be worried?
I would say that there's a spectrum of opinions in the market. Some are very bearish. They're very worried about a collapse in the property sector and with repercussions for the economy, we are on the more optimistic side.
Let me explain why; as opposed to say the challenges faced by the US and Europe, the challenges faced by China are 100% domestic and policy created. It's self-imposed Beijing made an explicit choice to impose a number of different policy restrictions. Many of which were concentrated in housing market and housing is absolutely key because housing dominates GDP, housing also dominates wealth.
You may have heard that housing and related activities account for about 25%, 30% of GDP, but in terms of private wealth housing accounts for 80%. So it's very important. If you have a collapse in the housing sector you need to deal with collapsing consumption and other domestic demand.
So why did Beijing crack down on the housing market? The chart shows something very important for investors to know, to keep in mind, and that is that Beijing has, I think based on my experience, close to 10 years, being very worried about a repeat of what happened in Japan 30 years ago.
And this is a chart that shows GDP growth of Japan. So you can see the shaded area was when the property market collapsed in Japan and this triggered a generation of lost output, basically zero growth for one generation, 30 years. China doesn't want the same thing to happen to them.
So they are preemptively trying to deflate the housing bubble. They believe that the housing cycle has gone too far relative to the demographics, wealth and GDP. Now, this is, this is why China is in a difficult situation. They want the bubble to deflate, but they don't want the bubble to collapse.
And that's why the policy stimulus that we're seeing are very peculiar. They're very different from post 2008, you have very targeted infrastructure spending, not like not very broad based fiscal stimulus, but targeted infrastructure, spending and monetary stimulus has been very modest and hesitant. This is the reason because they don't want to rekindle the property bubble.
They want to remove and reduce the risk of systemic risk in the long run. So what, how do we gauge where the economy will be a year, two years from now? And in the chart we show a dotted line, arrow going up, showing that the economy should converge back to the trend and that's for various reasons.
One is that policy stimulus has already commenced, there's even in addition to fiscal and monetary stimulus, there's regulatory forbearance. Policy makers are relaxing, the controls restrictions on the housing market, external demand is immensely strong this is not a story that people really focus on, but is, I think is a very important story. Trade surplus is running at 1.1 trillion dollars a year compared to 500 billion in 2019. And current account surplus has also exploded in size.
So external demand is really helping. Now why are we confident that the arrow will converge to the trend in the chart. And that's because China has always had medium term targets and they have actually been successful in achieving targets.
Many of you recall that in 2010, China announced that their goal was to double per capita GDP to 10,000 per person in 10 years time. So from 2010 to 2020, they wanted to double GDP and they achieved that. People didn't think that was possible, but they achieved it.
The next goal that they have declared, is to become the largest economy in the world, surpassing that of the United States, in 15 years. But to do that, they need to grow by 4% a year.
So I am, we are of the view that China is going through a purging, cleansing process to rid itself of a lingering risk in the long run, so that they can be allowed to prosper and grow.
So I see a conversion or reversion back to a trend of about 4, 4, maybe a little bit higher than 4% in the coming years.
What are your thoughts on the geopolitics of the region?
I think it's clear that the US is on to China. China has over the past 20 years, after being omitted as the full member of the WTO in 2001, has become very powerful, economically and also militarily and the US can no longer afford to treat China as a strategic partner, but a rival and the flashpoint is Taiwan for reasons that all of you in the audience should know, there are clear similarities between Taiwan and Ukraine.
But there are also important differences. There are, they may be technical differences to some in the audience, but they're very important to Beijing. One of which is that Taiwan is as recognized by the US, United Nations, China and Taiwan itself, a part of China. Taiwan is not an independent country, and therefore it makes it difficult
for Western powers to intervene in what to Beijing is a domestic issue. I'm not condoning this. I'm just saying, this is how the Chinese see the situation.
And the other difference is that Taiwan is an island. An island is more difficult to attack. It's also more difficult for NATO to resupply as well. So it does make the hurdle from both sides that much higher than say a land locked country like Ukraine.
There are other issues as well, but as it stands now, my understanding is that China does not yet have the military capability to confidently attack Taiwan and occupy Taiwan.
But in the next 5 to 10 years, the situation may be very different, and the US wants to take on the hawkest posture to ensure that that eventual conflict does not happen. And it's not also not in China's interest to get to that point either.
We have the G 20 meeting summit in Bali, in November, mid-November, and the leaders of the two countries will be there. They have an opportunity to meet, but my own guess is that there will be no breakthrough. This issue will basically hang over everybody for the next foreseeable future.
But I don't see a flashpoint. I don't see a major conflict in the near term for all the reasons that I mentioned.
What is your outlook for Chinese assets?
So what is our view? Our outlook for Chinese bonds and equities.
We were very confident that Chinese bonds should continue to perform well and equities are at a very fantastic entry price level.
This chart that you see shows what has happened so far this year, to various asset classes, and you can see that Chinese bonds have massively outperformed the rest.
It's probably the best performing asset class, outside commodities.
We see that soggy economic growth in China, the more worried we are, the more bad news there is in China, the better bonds should perform.
And also 98% of the bonds issued in China are issued by the public sector and Xi Jinping's administration favors the public sector to the private sector.
So we think bonds are even safer now than before. Equities may not perform exceptionally well, if economic growth is soggy, but growth is recovering accelerating, and the PE ratio is extremely cheap compared to 19X in 2020, PE is now down to about 15. Which is substantially lower than than the United States.
When the Chinese corporate earnings growth is comparable to the US earnings growth, so we expect earnings the PE ratio to, in China to recover toward maybe 17, 18X or so in the coming months.
So we're positive on bonds in China. Constructive on equities on a cyclical basis and on the Renminbi we're constructive as well.
We think the dollar has overshot and when the dollar corrects Renminbi will be a major beneficiary.
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