Many things continue to change fast in China, and our ‘China influence’ theme explores the implications as China’s influence on the world has grown exponentially, and as the country attempts to move its economy away from fixed investment towards consumption.
I recently returned from a whistle-stop tour of the country, taking in Beijing, Taiyuan, Wenzhou and Guangdong. I met companies, industry experts, consumer panels and government officials with the aim of getting as balanced a view as possible during the week-long trip. This blog contains some of my observations on how the world’s second-largest economy is evolving and thoughts on the investment outlook.
Manufacturing (and Trump)
The Pearl River Delta region in China’s Guangdong province remains the manufacturing hub of the world; even if low-end labour-intensive processes are outsourced to Vietnam and Bangladesh, the goods often come through the area for logistical reasons. The densely urbanised region is a vast and highly efficient ecosystem for designing, prototyping, customising, manufacturing and shipping almost anything at dramatically lower cost and faster speed than anywhere else: it is cheaper to ship to Los Angeles from the city of Shenzhen than from San Francisco!
In our view, President Trump would need to introduce very stiff tariffs for any of this production to shift to the US, but the majority would probably still remain in China, leading to a rise in the end price instead.
Interestingly, end-assembly is the most labour-intensive part of the production process, so bringing this part back to the US is where the labour cost differential would be most apparent. There is also the question of whether the US really wants manufacturing – it is a messy business, as can be seen from the smog and the waste-management trucks on Guangdong’s highways.
While 3D printing has reduced dramatically in cost, it is far from threatening mass production, which has also seen big falls in cost, particularly for items such as printed circuit boards and computer chips. Chinese companies are increasingly investing in innovation, and, while a typical factory might be 20% automated, some pilot lines now have 60-70% automation and this is clearly the direction of travel.
There are electric scooters everywhere and I barely recall seeing a petrol-driven motorbike or scooter over the five days of my visit. The downside is that you don’t hear the silent electric motors coming, and these scooters often have their lights off at night (presumably to preserve batteries), so we referred to them as the silent killers!
Electric vehicles (EVs) are a priority sector in China, with the government providing subsidies and support in this area. One of the ways the government can do this is via vehicle licence controls. Licences are already highly rationed in major cities in order to keep traffic in check, and it can currently take years to obtain one. However, the government can tilt policy by letting people ‘jump the queue’ if they will be driving an EV.
Charging infrastructure is apparently already quite well advanced on highways and, in Taiyuan, all city taxis are now EVs. The automotive consultant I met reckoned that EVs would form 20-30% of new vehicle sales by 2020.
Credit and housing
Most middle-class people barely use cash any more, favouring mobile and online payment services. They also now put most of their savings into wealth-management products (WMPs) – a source of much of the country’s credit growth. Peer-to-peer lending is also driven by financial technology, which has been much more readily adopted than in the West.
During the trip, I met representatives from both smaller and larger Chinese banks. Non-performing loans (NPLs) are significant: as a proportion of China’s total loan pool, it seems probable to us that NPLs could be as high as 20-40%, although declared levels are much lower. Inter-bank lending is how the credit is being directed to rocket-fuelled lending by some small and medium-sized banks.
Housing is seemingly still ticking along nicely, although I get the impression that the cycle is in its later stages and that the credit impetus has clearly slowed recently. There is a fair amount of housing development visible: most looks active, but I did see the occasional halted development, such as in Wenzhou. The local real-estate agent still invests most of his money in the local market and sees such evidence as isolated examples, typically where the developer lacked the right approvals; local government usually gets these completed in time.
Broadly, we remain happy to invest in sectors such as the internet, health care and education, where we think there remains significant growth potential. Education in particular is a very high priority in China, not least after-school tutoring, with several companies in this area well positioned for the sector’s continued growth.
Life insurance is another example, with general and health insurance highlighted by several consumers as an increasing outlet for savings, which in general are still very high, although millennials seem to have a more profligate mindset.
We remain very wary of Chinese banks, even if the People’s Bank of China does act as a backstop for inter-bank problems. As mentioned, we believe NPLs broadly appear very understated, and we think banks’ capital positions appear inappropriate. Housing seems set to slow with tightening policy and construction, and we think commodities are likely to react with a lag.
In our view, it is much better to focus on the structural winners where we can still find what we perceive to be fast-compounding cash flows with lower risk profiles.