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China and the global economy

What developments in China might mean for your clients’ portfolios

Your clients have been hearing about China a lot recently, particularly in terms of how its sluggish growth could impact the global economy. As Henry McVey, partner, head of Global Macro and Asset Allocation as well as CIO of the KKR Balance Sheet, puts it, “In recent months we had typically spent time focused on what sluggish growth and heightened politics mean for China and its counterparts in the region. Those points are certainly important ones that we must all factor into consideration, but during a recent trip to Asia, already my third trip of the year so far, I left thinking that the investment story in this region is evolving in a way that may be underappreciated by investors.”

To better understand that story, here’s a rundown of the major talking points, along with some tips on how to help your clients sort through the news while you provide them with practical guidance on the impact this news might have on their portfolios.

Sluggish growth, rising tensions

China’s growth rate was falling for months, raising concerns for investors. This past August, China’s growth rate began to fall from a brisk 8% annual pace to about 3%, the result of a combined storm of real estate industry failure, citizen loss of confidence in the government, and a reduction in the usually brisk consumption rate. However, the picture has since improved with “policy momentum since the end of August [exceeding] expectations,” according to a Citigroup economist. As a result, Wall Street raised the growth forecast to 5% in October, noting that the slowdown in China’s economy may “have hit bottom.”

But even hitting bottom, if it foretells continued sluggish growth, may well have an impact on global markets, an impact that is likely to be compounded by a number of other factors. "...the growth story in Asia is much bigger than China."For one, there have been growing tensions between the U.S. and China. Several U.S. states have worked to restrict Chinese investment in real estate and commercial investment. The U.S. has launched an effort to implement chip restrictions in China or technology exports to Chinese companies, partly as a result of a controversial announcement in early September that Chinese manufacturer Huawei had launched a powerful new Mate 60 phone, even though the company had been under restrictions for the past four years to curb access to 5G technology.

And that tension runs both ways. Major companies such as Tesla and Apple may now have reason to worry as Chinese consumers are choosing lower cost options for cars and phones. Major U.S. banks have remarked on slower growth, and Chinese tourists have been spending less time and money in the U.S. than in previous years, as evidenced by a 68% drop in traveler volume this year, resulting in a loss of $20 billion spent on travel and tourism.

China puzzle art illustration

Trouble for China at home, growing ties for America abroad

All of this is complicated in China itself by the overall disaffection of the nation’s youth, which is largely unemployed, underwhelmed, and disillusioned. In fact, roughly 20% of China’s Gen Z population (16-24 year-olds) is unemployed and not looking to return to the abusive work environments their parents tolerated. They are also expressing little interest in dating, getting married, buying a home, or having children—an attitude that’s been termed “the four nos.” Add to that the lowest fertility rate—1.07—since 1986 (the height of the country’s one-child policy), and it’s clear that China’s next generation does not seem optimistic about its country’s future.

And this is all coming at a time when the U.S. is strengthening its ties to China’s neighbors. President Joe Biden’s early September G20 visit with India and his subsequent stop in Vietnam weren’t designed to “contain” China, he said. “Instead, American’s goal is to get “the relationship right.”

"There is a transformation happening, and a new China is emerging to which all investors should pay attention."

What does China’s economic slide mean for its neighbors? On the one hand, Chinese households are likely to buy fewer goods and services from these countries. On the other hand, China’s economic crises may bode well for Taiwan: As Biden remarked during a press conference in Hanoi on September 10, China may be too busy focusing on its economic crisis to think about invading Taiwan.

What’s critical for investors, is remembering that, as McVey explains, “the growth story in Asia is much bigger than China. Across the region, growth in low-cost manufacturing of goods as a source of competitive advantage in the global economy has been overtaken by industrial services, including logistics, waste management, and data centers.”

Translating these trends for your clients

The China news can seem overwhelming, making it difficult to focus on specific areas of concern. Here are three areas your clients might be thinking about:

Stock market. China has been driving global economic growth for the past 20 years, and if that engine slows or stops, so does global economic growth. Potential for losses include U.S. companies with large manufacturing exposure in China, such as Apple, Intel, Ford, Tesla, Qualcomm, as well as other companies that rely on Chinese customers, such as Starbucks, Nike, and casino companies and resorts like Wynn, MGM, and Las Vegas Sands, which depend on China for two-thirds of their sales. Even companies not selling directly to China, such as ExxonMobil, will be affected as oil prices are likely to go down if Chinese growth slows. U.S. private equity, venture capital, and hedge funds have also been retreating.

Electric vehicles. Trade pressures on China will likely spill into the EV market. EVs seem to still be in short supply, and analysts suggest this might continue into 2024. China's growing dominance in the EV sector—China overtook Japan this year as the world’s largest auto exporter, 40% of which are EVs—will likely prompt U.S. officials to introduce regulations curbing U.S. trade and investment in the EV industry, though these efforts may not significantly challenge China's lead in both EV and broader automotive supply chains. While U.S. automakers are expected to resist these regulations, Chinese companies might strategically grow their footprint in places such as Mexico to sidestep U.S. trade barriers.

Housing market. China’s real estate sector—one of the strongest drivers of the country’s economy—is softening dramatically as a result of property developer defaults and weak buyer demand. Real estate giants are in a precarious position: Country Garden narrowly avoided default, and Evergrande filed for bankruptcy protection. Recent policy changes resulted in a burst of activity, but analysts believe that these short-term gains will not be sufficient to stabilize the market long term.

This leaves Chinese homebuyers looking to purchase homes in the U.S. In year-over-year numbers, Chinese homebuying in the U.S. has doubled, both in terms of the amount spent on U.S. residential properties ($13.6 million vs. $6.1 million) and as a percentage of foreign buyer purchases (13% vs. 6%). Chinese homebuyers also purchase homes at a median purchase price of $723,200, which is almost twice the U.S. median home price ($419,103).

New drivers emerging

However, it’s important to note that while these developments may be on your clients’ radar today, we believe they should also be considering how China’s economic growth drivers may shift in the future. For decades, real estate and exports were China’s economic engine—and we are now witnessing what happens when those economic drivers become economic draggers. But that is changing rapidly, and experts see new drivers ahead.

“Prior to COVID, a lot of market capitalization was created in China by entrepreneurs who leveraged technology to create an improvement in the consumer experience, including online shopping, social media, and e-commerce,” McVey says. “Today, by comparison, the new growth drivers of the Chinese economy look quite different: They are industrial digitalization and the energy transition. Our base view is that, over time, investors will talk more about these drivers than they will about housing and exports, both of which we think have already peaked as a percentage of GDP, and as such, now represent actual drags on the economy.”

With that in mind, we believe it’s clear that even though the news from China may look negative, there are still positives for your clients to consider. For one, Chinese exports are getting cheaper. As the factory to the world, a deflationary period in China would help keep prices low in other markets. For another, the Chinese economy will look different in the future, and with growth potential in areas beyond housing and exports. And for yet another, there is still time to discuss these issues with you and get advice on how to manage their portfolios. As McVey concludes, "There is a transformation happening, and a new China is emerging to which all investors should pay attention."

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