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China will avoid 2008-style investment boom

Lex Hall  |  05 May 2020Text size  Decrease  Increase  |  
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Don’t expect China to try to launch an investment boom to chart its way out of the corona crisis as it did after the 2008 meltdown.

The response will instead be more measured, and the indebted Middle Kingdom will look to tax cuts and subsidies to reboot growth and confidence.

As for those rosier growth figures, a new Morningstar report on China’s first quarter says Beijing may be underestimating the fall in output.

However, for some of China’s internet giants, Tencent and Alibaba, the worst may be over. We examine their fortunes later in this article, and include some investment ideas for the region.

We don't expect a repeat of China's post-2008 investment boom

we don't expect a repeat of 2008 investment boom

Source: China National Bureau of Statistics, Morningstar

Morningstar expects severe growth headwinds to persist in 2020, which it says will call for aggressive fiscal stimulus to shore up aggregate demand and rule out a domestic investment splurge because of the country’s “astronomical” leverage.

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“We don't expect a repeat of China's post-2008 investment boom, when the country was able to nearly fully offset collapsing trade with a surge in debt-fuelled domestic investment,” Morningstar says.

“This route is ruled out by China's astronomical leverage and the burden of its previous overinvestment,” which Morningstar says, left a hangover of high debt, unaffordable property prices, and overcapacity in several industries.

“Instead, we think tax cuts will play a much bigger role this time to increase consumer spending and ease the burden on ailing businesses.”

Headwinds on trade will continue throughout 2020

headwinds to persist

Morningstar expects increased government investment expenditures to merely offset falling private investment, leaving economy-wide investment flat year over year in 2020.

The Morningstar report coincides with dire business surveys on Monday, which show Asia’s factory activity retreated in April.

A series of Purchasing Managers’ Indexes from IHS Markit fell deeper into contraction from March, with some plumbing all-time lows and others hitting levels last seen during the GFC.

Debt-to-GDP ratio to surge

And China may be understating the damage from covid-19, according to Morningstar. Official real GDP growth for China was a record -6.8 per cent for the first quarter whereas Morningstar says its alternative broad proxy fell by 11.7 per cent.

China’s first-quarter decline likely even more severe than official GDP indicates

China's GDP v Morningstar proxy

Another problem China faces is an expected fall in exports as the shockwave of covid-19 reverberates through global markets.

Morningstar argues China will need “aggressive countercyclical policy” to offset very weak external demand and diminished domestic economic confidence.

China will need to increase its government budget deficit to around 12 per cent of GDP in 2020 in order to offset the severe hit to demand, Morningstar says.

It forecasts that China's debt/GDP ratio will surge to about 300 per cent of GDP in 2020 (from 260 per cent in 2019) as a result of its already very high leverage ratio and collapsing GDP growth.

Morningstar forecasts GDP growth of 2.1 per cent in 2020 for China

Morningstar gdp growth forecasts for china

Fixed-asset investment growth was weak across the board, with declines of 25.2 per cent for manufacturing, 19.5 per cent for infrastructure, and 12 per cent for real estate.

Similarly, real estate activity, including residential starts and sales, suffered. Both state and private-sector spending fell by 12.8 per cent and 17.9 per cent, respectively, in the first quarter, modestly better than the 20 per cent-plus drops in the first two months

Morningstar says that instead of resorting to traditional bricks-and-mortar projects, China will instead seek to focus stimulatory investment on “new infrastructure” such as 5G networks and data centres.

“Construction has resumed for most key infrastructure projects, and we expect more projects to come to create jobs.

“This should benefit infrastructure-related names in the near term, including construction companies, cement manufacturers, and steel producers.”

Demand to remain weak

Covid-19 has also choked consumer demand. Retail sales fell 22 per cent, despite the strength and ubiquity of online commerce in China.

And there’s also evidence China’s younger shoppers are turning to second-hand goods. Government researchers predict that transactions for used goods in China may top 1 trillion yuan ($218 billion) this year, Reuters reports.

This coincides with a burgeoning push to more minimalist spending habits. Posts with the hashtag #ditchyourstuff have trended on Chinese social media in recent weeks, garnering more than 140 million views.

But that trend may have to reverse if China is to offset the projected fall in exports, Morningstar says.

“We expect export demand to remain weak for much of 2020, meaning China's consumers will need to spend more if output of China's factories is to be absorbed.”

Snapshot: China-exposed companies

Two long-term beneficiaries of the outbreak could be Tencent and Alibaba, says Morningstar equity Chelsey Tam.  

Tencent (00700)

In February, Tam said Chinese internet giant Tencent would be a resilient play during the covid-19 crisis and indeed it has only fallen 1 per cent since the 20 February sell-off and is currently at fair value. The company, whose major services include communication and social networking (Weixin/WeChat and QQ), online PC and mobile games, content, utilities, the cloud, and financial technology. Tencent has an aggregate monthly active user base of over 800 million for QQ and 1 billion for Weixin/WeChat. It has also made headlines in Australia by taking a 5 per cent stake in buy-now-pay-later provider Afterpay Touch Group. Tam says gaming and e-commerce will continue to be key earnings pillars. “Tencent’s online gaming business will retain its dominant position based on its strong distribution capability and research and development investment. Tencent’s strategic investment in content, cloud, and e-finance will lay a strong foundation and drive earnings for the group in the long term.”

Alibaba (BABA)

Alibaba is the world’s largest online and mobile commerce company. It operates China’s most-visited online marketplaces, including Taobao (consumer-to-consumer) and Tmall (business-to-consumer). Alibaba's China marketplaces accounted for 68 per cent of revenue in fiscal 2019, with Taobao generating revenue through advertising and other merchant data services and Tmall deriving revenue from commission fees. “Its strong network effect, largest scale and best-in-class cash flow generation and profitability in the Chinese e-commerce industry, vast digital ecosystem, and synergies among businesses will allow Alibaba’s e-commerce business to emerge from COVID-19 stronger than before,” says Tam.

ETFs and funds

Australian investors can also gain exposure to Chinese companies—and Asian names more broadly—via exchanged-traded and funds. Platinum Asset Management’s Asia Fund includes Tencent as its top holding, followed by Alibaba, Taiwan Semiconductor Manufacturing Co, Samsung Electronics, pan-Asia life insurance giant AIA Group, and JD.com, an e-commerce giant and rival to Alibaba. The Platinum Asia Fund carries a Morningstar Gold rating. Minimum investment is $10,000 and the management fee is 1.35 per cent.

Platinum also has an Asia-themed ETF called PAXX, whose holdings resemble those of the Platinum Asia Fund. A slightly cheaper that also carries a Morningstar Bronze rating is the iShares Asia 50 ETF (AU), IAA. IAA is the largest Australian ETF that delivers a regionally diversified Asian equity portfolio, but there are alternatives outside Morningstar coverage. Some include:

Prem Icon Morningstar's Global Best Ideas list is out now. Morningstar Premium subscribers can view the list here.

Prem Icon See also Morningstar Guide to International Investing

The author owns shares in the BetaShares Asian Tech Tigers ETF

is senior editor for Morningstar Australia

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