By Joseph Goldy, AAMS®
As world economies continue to grow and evolve, it is becoming increasingly evident that China is playing a larger role in that growth. Some projections have China's GDP reaching $64 trillion by 2030, up from $14 trillion in 2019. By almost any measure, the Chinese economy is experiencing expansion that will likely continue in the decade to come. Still, it also has unique headwinds that it will need to overcome as well.
Certain areas of the Chinese economy, such as consumer discretionary spending, healthcare, and environmental/renewable energy, are all poised to be significant growth drivers due to the country's changing demographics and continued investment by the Chinese government and foreign firms.
Concerning consumer purchasing, one report shows discretionary spending in China responsible for 50% of global consumption in less than ten years as more of the country's population reaches middle-income status. According to KraneShares, total retail sales have already surpassed the U.S. as of 2019.
Retail
Chinese retail web sales totaled $1.5 trillion in 2019, a 16.5% increase over the previous year, and eclipsed the $600 billion in retail web sales of the United States. Having exposure to companies in critical industries such as e-commerce, 5G, semiconductors, and financial services, among others, will be necessary for most people considering investing in China.
Healthcare
Due to the Chinese population's overall aging, the country is also one of the fastest-growing healthcare markets globally, seeing 13% annual growth over the last ten years. Rising urbanization and higher incomes will likely continue to drive this trend in the years ahead.
According to a 2018 article by Frank Ledue of McKinsey & Company, China's urban population will reach 1 billion by 2030, with approximately half of those people achieving middle-income status. Mr. Ledue's article highlights that by 2030 100 million people will be over 65, which is more than Germany's entire population. Accordingly, a wealthier segment of society will demand a higher level of care to address various common health issues.
Energy
Energy and the environment are perhaps some of the fastest growing industries in China. The country is already a world leader in total renewable energy with 31% of global capacity. The Chinese government is hoping to have renewables comprise 35% of their total consumption by 2030. Wind, solar, and nuclear are all seeing large amounts of investment dollars flowing into their respective industries and will play an ever-increasing role in the country's total energy portfolio.
The Chinese leadership is laser-focused on increasing the share of renewables in the overall energy mix. This area has been a significant focus of China's Five-Year Plan. According to Invesco, President Xi Jinping recently doubled down, saying their new target for carbon dioxide per unit of GDP will decline 65% by 2030 compared to 2005.
Highland's investment committee recently researched whether China deserved to be a standalone position in our portfolios. We found that although China's weighted share of emerging market indices is growing, it trails the real impact the country is having on the global economy and does not accurately reflect the genuine economic opportunity that mainland Chinese companies present.
Our research discovered a significant difference between investing in Chinese mainland companies through A shares (shares of Chinese companies listed on the Shenzhen or Shanghai market) versus companies that trade on the Hong Kong exchange, which are known as H shares.
The ability to invest directly in companies domiciled in mainland China is a relatively recent occurrence. In 2014, a program called Stock Connect launched and essentially created a link for foreign investors to invest in companies trading on the Shanghai stock market. The program then expanded to include the Shenzhen exchange shortly later.
The Stock Connect program opened the Chinese mainland stock market to outside investors like never before. It simultaneously created a significant opportunity for professional money managers since 90% of the market is controlled by retail investors. Such a large swath of the mainland Chinese stock market driven by retail investors has meant increased volatility and potential inefficiencies compared to a more mature equity market like that of Hong Kong or the U.S.
Risks to Consider When Investing in China
Not surprisingly, our investment committee found that despite the opportunity investing in mainland China-based companies presents, it comes with specific risks. For instance, there is a mix of Chinese state-owned enterprises (SOEs) trading alongside non-SOE companies. Eliminating SOEs is missing out on potential gains since many operate in critical industries such as transportation and communications. However, doing the necessary due diligence to avoid companies and industries that are inefficient with poor future earnings prospects could be daunting for some retail investors.
A more macro risk from a demographic standpoint is that China faces an aging population that could cause a strain on its healthcare system in the near-term. Due to a combination of geography and skills not aligning with demand in China's large urban areas, an absence of young technology-skilled workers is causing a labor shortage in specific industries. Some companies have turned to in-house training programs, but a scarcity of talent is a larger issue that China will have to overcome in the future.
Another potential risk is China falling into the "middle-income trap." A paper written by Matthew Higgins, vice president at the Federal Reserve Bank of New York, highlighted this danger. In his report, Mr. Higgins pointed to many countries that displayed high GDP growth in the past but then leveled off, as shown in the chart below.
Unfortunately, they begin to stagnate as growth normalizes and ultimately prevents them from reaching high-income status. While this is a potential risk, the Chinese government is doing everything in its power to ensure this does not happen. And while China's GDP has slowed somewhat in recent years, it is still north of 6% as of 2019, which, if sustained, would keep it on the path toward high-income status.
While China is not without its challenges, the growth the country has seen is real. Yet, navigating any country's investment landscape can be challenging for individual investors, particularly with China, since their Shanghai and Shenzhen stock markets have only recently opened to outside investors. Likewise, knowing how much to allocate to a dedicated China fund position and how it may work with existing emerging market fund positions requires doing some research.
Ultimately though, from an investment standpoint, participating in China's continued growth story warrants closer examination, and it will be interesting to see how this story plays out in the coming years.
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Author’s Bio
Joseph Goldy, CFP®, is a wealth advisor and CERTIFIED FINANCIAL PLANNER™ at Highland Financial Advisors, LLC, a fee-only fiduciary wealth advisory firm based in Wayne, New Jersey.
Joe specializes in working with newly independent women because of divorce or losing a spouse. He understands firsthand the value of having a clear financial picture pre- and post-divorce and a plan to restate goals as a single person. When he is not helping clients, Joe enjoys spending time with his two sons outdoors and volunteering to help raise money for Type 1 diabetes organizations.