Global equity markets seem to be grinding higher from the significant low in the fourth quarter of last year. This adjustment process is varying across markets due to regional factors, differing inflation and growth outlooks and has also been hit with fresh shocks such as financial stresses across some developed market banks.
The continual buffeting of markets by macroeconomic shocks may tempt investors to take a short-term view of their investment strategy. However, this would fail to acknowledge the long-term benefits of staying invested resulting from key structural trends taking shape globally, especially when attractive entry-points are on offer.
Across Asian markets, various structural trends are playing out that investors should be looking to engage with as soon as possible. A key one is the ‘Great Power Competition’, which is generating geopolitical tensions between the East and West and contributing to a ‘Great Decoupling’ that we are seeing as we move towards a world with more than one centre of power.
For a big part of our lifetimes, a global trend towards a unipolar world with the United States as the centre of global power has been the norm. Over the past decade, this trend has slowed, with the rise of China showing that the world is more likely to be bipolar, if not multipolar.
More recently, geopolitical friction between the East and West has increased. The impact of the trade war between the US and China, coupled with rising tension between Russia and the West, has created uncertainty across global markets, and contributed to a rising trend in levels of geopolitical risk. The associated economic effects of this, we believe, are worth considering.
Geopolitical risks since 1998
Source: A news-based measure of adverse geopolitical events and associated risks since 1900. The geopolitical risk index spiked last year, and around the two world wars (WW2=100, which is the worst period), at the Korean War, during the Cuban Missile Crisis, and with the Iraq War (2003). From Caldara, Dario and Lacoviello, April 2023.
The investment case for China in an era of rising tensions
The potential economic effects of rising geopolitical risks, include an increase in domestic manufacturing and supply chain onshoring over time, which may, in turn, boost the return performance from industrials, like the machinery sector.
An advantage to Asia, and especially China, is that many firms that are already global leaders in these fields have significant global market share. Many of these Asian corporate leaders are concentrated across investment sectors such as IT (especially cloud services, and mobile devices), and also in machinery (namely in semiconductors and robotics).
Greater geopolitical risks have also highlighted the need for countries to accelerate the transition away from fossil fuels to clean and renewable energy. As the shift to greener forms of energy takes time, transitional energy sources like natural gas are likely to remain prominent over the adjustment process.
China also has leaders in the climate protection space including around solar panels, EV batteries, and renewable energy storage systems. One example is Ningbo Orient Wire & Cable, which has benefited from increased demand for wind energy in both China and abroad . The company already ranks within the global top three offshore energy cable providers and is one of the most advanced technology providers for deep-water energy and transmission solutions.
The ‘Great Decoupling’
China has been investing heavily in its domestic economy, particularly in technology and innovation. The Chinese Communist Party’s ‘Made in China 2025’ initiative aims to make it a global competitor in high-tech industries, such as artificial intelligence, positioning itself as an alternative to Western countries and thus able to resist the economic impact of rising tensions.
Also, China has taken steps to reduce its reliance on Western markets by developing new financial relationships. For example, through the expansion of its ‘Belt and Road’ initiative that aims to connect China with Europe, Africa and the Middle East through infrastructure projects.
China is also a key member of the Regional Comprehensive Economic Partnership (RECP, in effect since Jan 2022) which has created the world’s largest trade bloc across the Asia-Pacific nations. It is relationships like this that illustrate China’s attempts to ‘decouple’ from Western economic interdependence as geopolitical tensions between East and West rise. We believe this trend may have a positive effect for Asian equities over the long-term.
However, there is also a risk that increased geopolitical tensions internationally will lead to push-back against favourable globalisation trends such as free-trade and capital flows. This is a scenario that may lead to headwinds across markets, however Asian firms may have some resilience to this due to the large share of global trade that is owned by Asia.
For the here and now, a key test for Asia’s ‘Great Decoupling’ hypothesis is whether its favourable fundamentals and policy supports will materialise in the much stronger growth performance that forecasters expect for the next couple of years.
Asia’s Great Growth Decoupling - Real GDP Growth Forecasts (YoY%) and Forecast Change in Growth from 2022 to 2023 (%pts)
Source: Bloomberg Consensus Forecasts 30 March 2023
Common prosperity
Although some investors have become more bearish on China’s outlook after the 20th Party Congress with the belief that the ongoing pursuit of ‘common prosperity’ implies that growth is no longer a priority, we remain positive on China as a long-term investment destination.
If China can sustain the growth of its per capita income over time (which is what ‘common prosperity’ aims to achieve), this would be a positive long-term development. In this instance, this may ultimately prove more important to its equity market performance than specific GDP targets.
China’s Growth Outperformance over Value stocks has correlated positively with Income per capita trends
Source: Refinitiv Datastream, April 2023
It is for these reasons that we believe that investors should be looking to China as a positive investment destination, despite the economic and geopolitical headwinds that dominate the headlines.
Robert St Clair is head of investment strategy at Fullerton Fund Management. The views expressed above should not be taken as investment advice.