Amid a flurry of negative headlines this year, not all fair and balanced in my opinion, many global allocators have been grappling with the risks of investing in China equity. While there are indeed risks to be aware of (as with any investment), I believe there is also no shortage of potentially attractive opportunities for patient, discerning stock pickers.
US/China relationship not “breaking up” anytime soon
When evaluating the opportunity set in China equity, it is important to bear in mind the potent incentives for both the US and China to maintain a collaborative ongoing relationship, given the substantial capital market, supply-chain, and trade interdependencies between the world’s two largest economies.
China remains one of the most critical trading partners for the US. It is the largest importer into the US and the third-largest recipient of US exports1. Additionally, US and global supply chains are deeply embedded in China. While there has been an increased trend toward nearshoring and “friendshoring” in recent years as companies look to build resiliency into supply chains, many companies are not able to quickly or completely extract their supply chains from China. For example, China is in many respects the global leader in supplying the renewable energy transition. It dominates the solar power supply chain, controlling 70% – 95% of that chain’s segments2. It also controls most of the processing of critical materials for the energy transition. The US and Europe would be challenged to replicate the supply chains needed for a successful energy transition without China. In addition to physical goods, China is also a critical supplier of capital as the world’s largest holder of foreign exchange and the third-largest holder of US Treasury debt3.
From China’s perspective, the relationship with the US also remains highly strategic. China reiterated its commitment to global integration and opening up during the recent Party Congress. The Chinese economy will need to navigate substantial demographic shifts in the years to come in the form of a shrinking working-age population and a growing retiree population. The country relies on US and other global end markets as buyers for its exports, which make up 20% of GDP4. The US is the largest importer (by country/region) of Chinese goods by dollar value by twofold over the second-largest importer (other than Hong Kong), Japan . Clearly, the economic linkages between the US and China remain strong and will likely remain so, in my view.