Chinese stocks have had a tumultuous year as a wave of stricter regulation rocked tech, education and gaming stocks.
Yet China’s general attractiveness to investors remains unchanged. Individual stocks suffered massive sell-offs and the confidence of some foreign investors was tested by the industry crackdowns.
But assets in China will regain their appeal once they are viewed in the context of how Chinese monetary policy is moving relative to what is happening in the United States.
US financial markets remain largely supported by central bank liquidity, which cannot be counted on as inflation accelerates. Uncertainty about the end of this dynamic will weigh more and more on US growth stocks.
On the other hand, we believe that China’s pursuit of its strategic objectives will continue to stimulate the country’s rise in investor portfolios.
These include rebalancing China’s growth engine – from exports to domestic demand – with a focus on supply chain independence and security. Even the current regulatory pressure should be seen as a tool to stimulate competition and reduce systemic risks, both of which are essential for attracting capital.
The internationalization of the renminbi as a currency of exchange, capital, reserves and savings is also essential for investors. At the start of the pandemic, China resisted the temptation to embark on unorthodox monetary and fiscal experiments.
This was in stark contrast to the United States, which experienced the greatest central bank-government intervention of all time, overturning all principles of financial discipline. For its part, China has remained ready to support its economy, but in such a way as to protect its currency.
Notably, in Asia, the renminbi plays a role similar to that of the Deutsche Mark in Europe four decades ago. Although there is no official fixed rate, central banks effectively monitor the levels and volatility of most regional currencies against the renminbi. This nascent Asian currency bloc will provide some insulation against headwinds linked to the United States and further strengthen trade ties within the region.
The next wave of asset purchases in the United States by the Federal Reserve, in the face of mounting inflationary pressures and rising interest rates, could also encourage the internationalization of the renminbi, as the emerging economies and investors in general are looking to reduce their dependence on the US dollar.
Indeed, around 30% of central banks worldwide plan to increase their allocation to the renminbi over the next two years. Another sign is the announcement at the end of July that the People’s Bank of China will support the Shanghai trial to facilitate the free trade of the renminbi. For investors, there are three implications.
First, Chinese assets, cash and government bonds in particular are likely to be the main haven for positive real returns for the foreseeable future.
Indeed, recent hyperkeynesianism in the United States comes at its own price in terms of rising inflation, devaluation of the currency, and a higher risk premium. For investors, preserving purchasing power per unit of risk will be the rule of the game in a more inflationary world where real returns will matter most.
Second, the greater autonomy of the Chinese economic cycle will provide better diversification benefits and exposure to areas of higher future growth.
The development of the middle class and domestic consumption can help reduce China’s dependence on world trade.
Advances in the manufacturing value chain through innovation will provide opportunities in strategic sectors such as semiconductors, artificial intelligence, quantum computing, clean technologies, industrial automation and robotics.
Chinese growth stocks are currently largely internet giants. As local champions develop from this local innovation dynamic, a broader set of growth companies will be available for investors seeking to diversify risk.
Third, global investors are likely to view the renminbi as both a store of value and a medium of exchange.
As the second largest holder of US Treasuries in the world, China has little interest in precipitating a disorderly fall in the dollar.
But as China becomes more independent, this residual financial link will give it additional negotiating leverage in future trade and tariff negotiations.
There are good reasons for investors to take a gradual ‘go it alone’ approach to Chinese assets. As the Chinese saying goes, “All things are difficult before they are easy”.