What in the world is going on in China? What in the world is going on in China? http://www.federatedinvestors.com/static/images/fhi/fed-hermes-logo-amp.png http://www.federatedinvestors.com/daf\images\insights\article\hong-kong-junkboat-small.jpg September 29 2021 September 29 2021

What in the world is going on in China?

Investors uncertain as country shifts from fighting poverty to fighting inequality.

Published September 29 2021
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A crackdown on big tech companies and video game usage. A declaration that crypto transactions are illegal. Looking the other way as a highly indebted homebuilding giant skips bond payments. This is not the China markets have come to know. Then again, this is not the same China, either. After 40 years of allowing, if not encouraging, individuals to build mega-companies and great wealth under market-oriented reforms championed by Deng Xiaoping, the Chinese Communist Party under emergent strongman President Xi Jinping is taking a different tack.

Reinstating a strong central government’s dominant role in shaping the economy, the party is reining in companies that stray from its directives and punishing businessmen whose voices are louder than its own. It wants to share the enormous wealth that has been created by industry so far this century—per capita GDP in China more than doubled the past 10 years and grew more than tenfold the past 20—with everyday Chinese citizens. While the mechanics of this so-called Common Prosperity initiative are ill-defined, the hope is a larger, more vibrant and stable middle-class can help China overcome a major structural impediment, a shrinking working-age population, and overtake the U.S. as the world’s global leader in the technologies of tomorrow. Components include:

  • Family values The government wants to make sure China has a sufficiently large and well-educated work force. Part of that entails focusing on the root causes of why families are unwilling to have children by addressing issues such as the high cost of education, expensive housing and barriers for women in the workforce. Some recent examples of this are government crackdowns on test-prepping companies, video game usage, and gambling.
  • Growth no longer ‘Priority No. 1’ Party officials are willing to sacrifice short-term economic growth in favor of long-term objectives. For example, the Peoples Bank of China bucked the ultra-accommodative trend of other leading central banks during the Covid crisis, maintaining a tighter monetary policy to discourage overinvestment by companies, inhibit inflationary pressures and forestall additional pressures on credit. Unsurprisingly, recent economic data reflects a slowing Chinese economy—an outcome that we don’t think China will allow to continue, though it seems willing to let growth settle at lower ranges than the near double-digits of the past decade.
  • Gearing down the property growth engine China’s property boom—Empirical Research estimates residential investment there is equivalent to 2% of global GDP, higher than the U.S.’s share just before the global financial crisis—drove China’s economy the past dozen years, accounting for nearly a third of its GDP when knock-on effects are included. But excess supply, coupled with flat population growth, point to a potentially extended period of decline for real estate investors. There is enough available property in China to house over 90 million people.

What will these changes mean for investors? China isn’t going away. It’s the world’s second-largest economy and is on a trajectory to overtake the U.S. in the coming decade. What happens there will continue to play a major role throughout the world, with its demand for resources spilling over into commodity markets everywhere and its industries supplying countries everywhere. So, its influence is and will remain significant. But Common Prosperity is certain to impact corporate profits via higher regulatory fees, required donations to nonprofits, higher labor costs, etc., and seems certain to make China a more inward-focused country.

To be sure, new regulations aren’t always bad. There have been excesses. Evergrande, the aforementioned property giant, is just one. Comparisons can be drawn to the monopolistic practices of U.S. steel, auto and railroad industries in the early 1900s that stifled competition and whose unsafe, exploitative working conditions did little to expand the middle class. Because China’s capital markets initially had little to no rules, many of its companies grew unchecked. That’s changing now—Cornerstone Macro counts over 103 regulatory moves since last fall—so questions on how much further these regulations may go are many. Until we get more clarity, the lesson for investors may be, when it comes to China, it’s arguably swim at your own risk these days.

Tags International/Global . Equity . Active Management .

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