China's Year of the Rat beckons new opportunities

Zodiac years and their associated signs have particular importance in Chinese culture and can wield broader influence over decisions in a way that is incomparable to the star signs used in western culture. The zodiac impacts consumer and economic activity. For example, wedding dates, the timing of property purchases, job changes or starting a family or business can all be influenced by Chinese zodiac signs.

2020 heralds the Year of the Rat and it represents a new beginning. With a phase-one trade deal signed with the US, and the nation’s strong economic growth expanding output, it could be a new beginning for the Chinese economy and share market.

The rat is associated with leadership and China is clearly focused on being the leader. The nation has been the largest single contributor to world growth since the global financial crisis (GFC) of 2008,¹the previous Year of the Rat. Smart leadership in China has helped to propel that growth. This year, we are likely to see more economic success as China emerges from its ‘trade war’ with the US.

According to Chinese folklore, rats are clever, even in times of scarcity they know where sacks of grain can be found. They are opportunists and like to be ahead of the game. This appears to be true of China too. One of our key messages at the start of last year was “Don’t fight the PBOC (People’s Bank of China).” China was addressing its debt bubble in a very balanced and attentive way then, and as we predicted, this drip stimulus approach has been effective. The economy is predicted to grow 5.8% in 2020, more than three times faster than the average of developed economies, according to IMF forecasts. Australia’s economic growth is forecast at just 2.3% in 2020, while the US economy is predicted to inch forward by just 2.1%. This trend of stronger growth in China is likely to be sustained for a long time, with rapid urbanisation and modernisation driving a huge jump in consumption and economic output.

Opportunity abounds

As the Chinese Lunar New Year gets underway, there is a huge opportunity for the rest of the world to take advantage of sustained faster growth in China. In particular, investors who act now to understand the economic dynamics in China and invest in the nation’s rapidly developing share market will potentially reap some of the greatest benefits over the long term. As the Governor of the Reserve Bank of Australia has made clear: “we all have a strong interest in understanding China.”²

China alone accounts for 39% of global growth³and its share of economic activity is rising as the nation’s population of around 1.5 billion⁴people gains wealth and consumes ever more. China will inevitably overtake the US as the world’s largest economy, possibly this year, according to a forecast from Standard Chartered.⁵

Rapid growth has helped feed significant expansion in the Chinese share market. Combined, the mainland China exchanges in Shanghai and Shenzhen now form the second largest share market in the world after the US. Reflecting their growing importance, index provider MSCI in 2019 boosted the inclusion of mainland Chinese shares, known as China A-shares, in its MSCI Emerging Markets indices. The inclusion factor for China A-shares in the MSCI China Index was increased to 20% in 2019 from just 5% at the beginning of the year. China A-shares now have weights of 12.1% and 4.1% in the MSCI China and MSCI Emerging Markets indices, respectively.⁶

This has fed greater institutional flows into the onshore capital markets, driving up share prices. In 2019, China A-shares have easily outperformed the US share market, up 38.4% over the 12 months to 31 December 2019, as measured by the benchmark CSI 300 Index, compared to 32.0% for S&P 500 Index and 23.4% for the S&P/ASX 200 Accumulation Index. This significant Sino outperformance may continue through the Year of the Rat and over the long term.

Your allocation to China needs to be more than zero

Most global investors don’t have a zero weight in US equities. Why? Because the US is too important to global growth and it also offers opportunities not available in Australia. China is also important for global trade and it too offers opportunities unlike any offered in Australia, or for that matter in the US, but most Australian investors do not own China A-shares.

As China’s economy races forward, some of the most lucrative investment opportunities lie in China’s ‘new economy’ sectors, that is, technology, healthcare and consumer goods and services. These sectors are benefitting from China’s rising incomes and living standards and the expansion of its middle and upper classes.

Technology in particular is at the centre of China’s changing relationship with the world, according to consultants McKinsey. The Chinese technology sector now rivals that of the US for innovation and growth, which is adding to trade tensions. This has been underpinned by the government’s huge level of research and development investment, with China the world’s second-largest spender at US$273 billion in 2018, behind only the US.⁷As the rat likes to lead, China could become the biggest technology R&D spender in 2020.

According to the McKinsey Global Institute China-World Exposure Index, the world’s exposure to China has increased while China’s exposure to the world in trade, technology and capital, has fallen in relative terms. This reflects the rebalancing of the Chinese economy toward domestic consumption.

China’s consumer market is likely to remain buoyant on the back of rising incomes. The aging population too and higher incomes are leading to growth in healthcare goods and services and pharmaceutical consumption. We are also already seeing tremendous growth in discretionary incomes and consumption, with upmarket European fashion brands such as Prada and Gucci opening up shops across China at a rapid rate. The nation’s wealth is beckoning offshore investment and brands. Wealthier consumers will demand more upmarket goods and services rather than the basics like food and clothing.

Opportunities to participate in China’s wealth creation potential

China is the world’s growth engine and its new economy is one of the greatest potential sources of investment returns over the medium to long term. In the Year of the Rat, there are significant opportunities for Australian investors to include an allocation greater than zero to China.

There are limited ways through which Australian investors can acquire China A-shares. Only VanEck offers specific China A-share ETFs so that investors can participate in what may be the next growth phase for domestic China investments.

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_{¹https://www.worldbank.org/en/country/china/overview
²https://www.rba.gov.au/speeches/2018/pdf/sp-gov-2018-05-23.pdf
³https://www.imf.org/en/News/Articles/2019/10/18/na102319-prolonged-uncertainty-weighs-on-asias-economy
⁴https://www.worldometers.info/world-population/china-population/
⁵https://www.ft.com/content/7500eb04-dfb6-11e9-b8e0-026e07cbe5b4
⁶https://www.msci.com/eqb/pressreleases/archive/MSCI_Nov19_QIRPR.pdf
⁷https://www.mckinsey.com/~/media/McKinsey/Featured%20Insights/China/China%20and%20the%20world%20Inside%20the%20dynamics%20of%20a%20changing%20relationship/MGI-China-and-the-world-Executive-Summary-vF.ashx}