In 2021, the financial markets will discover… China

“Nothing can stop China. Not even the most serious health crisis since 1918. Xi Jinping can boast about achieving positive growth in 2020. He is the only one” writes Rémi Godeau. Western investors are going to see a good many of their past convictions challenged. This will mean that the underweight position of China in global portfolios is bound to change. And this is going to make waves…

This column was previously published in “Les cahiers de l’Opinion”, on 15th january 2021

In 2001, China rose to the challenge of becoming part of the World Trade Organization. And, to the great surprise of the rest of the world, in two decades it became the “world’s factory”. Could it be that, in 2021, China is preparing itself to join the world finance system and reshape it to its own advantage? Although the best Chinese companies traditionally used the American ADR market to finance their development, in 2020 it was international investors who, with the Covid crisis in full swing, drew closer to China by investing almost $150 billion in it — 80% of which was in the debt market. At the same time, the largest American banks ignored President Trump’s admonitions and hastened to take advantage of regulatory change by buying up local partners in joint ventures with China — a sign of confidence in the country’s future.

Three favorable factors

China is severely under-represented in investment portfolios worldwide — only 3% — whereas China’s GDP accounts for 15% of the world economy and a good third of its growth. This is going to change over the next decade, and there are three main reasons for this.

The attraction of growth. First of all, in the very short term, investors are desperately in search of a new growth cycle and this — an unprecedented occurrence — is basically only to be found in China. The USA and Europe will take a certain amount of time to get back to their 2019 growth rate, whilst the Chinese GDP, having reached +2% in 2020, should increase to something like +8% in 2021, in line with its long term annual growth rate of +5%, facilitated by the necessarily accommodating policy of the central bank. This growth is produced by three traditional factors that will shape the next cycle: firstly, a forced march into the technology revolution, as shown in the construction of infrastructure for the new connectivity (e.g. 5G) and in the development of new applications (from live streaming to smart manufacturing). Secondly, the strong desire to take up the impossible environmental challenge, aiming at carbon neutrality by 2060, by means of an incredible gamble on solar and wind energy which together are due to produce almost 60% of Chinese energy by 2060, as opposed to only 10% today. The third driver of growth is the Chinese consumer. As bold as ever, consumers are now more attracted by need rather than desire. They are ever more demanding in the fields of healthcare, education, nutrition, entertainment and tourism.

International investors are turning to Chinese markets because they have understood that the pangolin of 2020 is in fact the harbinger of the revolution to come in the next decade — the speeding-up of digitalization

The speeding-up of digitalization. However, fundamentally, international investors are turning to Chinese markets because they have understood that the pangolin of 2020 is in fact the harbinger of the revolution to come in the next decade — the speeding-up of digitalization. It is by the systematic digitalization of all services that China will be able to avoid the middle income trap and reinvent itself as the new “world’s butler” and the ruler of the new sharing economy: a country where seven million students graduate every year has no choice but to promote a video class of 3,000 students, like the one proposed by Youdao, the innovative subsidiary of the Netease Group; overcrowded hospitals dealing with eight billion visits every year see the only solution in teleconsultations, such as those proposed by PingAn Good Doctor; mass penetration — at affordable prices — of life and health insurance can only be obtained by a new digital conception and distribution of policies, like those implemented by the newcomer ZhongAn.

Minimal monetary risk. Thirdly, by investing more in China, global investors will, paradoxically, be able to protect themselves from the risk of a monetary crisis in the West. History seems to want a follow-up to the 2008 financial crisis, which the daily rise of the bitcoin seems to indicate. The PBOC (the Chinese central bank) is openly showing its determination to strengthen the credibility of the RMB against the dollar and the euro by refusing to monetize its domestic debt, in contrast to its American and European counterparts, by speeding up its pilot projects for a digital RMB, reminding us that in this time of a “Cold Peace” with the USA, a strong country will be the one with a strong currency. How long will Western institutional investors resist the temptation of Chinese10-year Treasury Bonds, which offer an annual return of over 3% — i.e. 250 base points more than the American equivalent — and which, if combined with an annual currency appreciation of 3% to 4%, would produce an annual return of about 6% to 7% in dollars or euros? This makes it easy to understand that any future war between the USA and China will be about balances of payments, for China intends to try and attract part of global savings — notably from Japan and Europe — after having financed the excessive American lifestyle for half a century.

An upside-down world

So, welcome to the upside-down world of 2021, in which Western investors will see a great many of their past convictions challenged. Firstly, because of the need to take a new look at the risk represented by China. Today, this is illustrated by the low valuations of Chinese companies — often only half that of their American competitors. This reflects an Equity-risk premium of 8–10%, i.e. twice the level of what it is in the West. The risks presented by Chinese-style state capitalism cannot be denied, but the West often judges state intervention too quickly, as shown recently in the case of the Ant Group and Alibaba — Westerners should not take the simplistic view that this is some sort of heavy-handed arbitrary Communist intervention.

The 2021 recovery will be different from others in the past in that it will be K-shaped — a nice concept that macro-economists use to describe a recovery that is basically unequal, a factor amplified by the business model of the digital revolution, in which the absence of marginal costs means that “the winner takes all”. In a country where 600 million inhabitants still only earn $150 a month, investors should expect to see the Chinese government regulate the digital giants as a preventative measure, reminding them of their social responsibility, rather than letting them prosper boundlessly as in the USA or attempting in vain to hold them back with belated measures, as is the case in Europe. However, this will not prevent growth investors from identifying the opportunities that come from the innate entrepreneurial spirit of the Chinese private sector — the holy grail for growth investors of a combined growth in turnover and EBITDA margin exceeding 40%.

It is in China that “thematic investment” could fully blossom in the next decade, dethroning value investing and growth investing so dear to the West

Long Term. But the main pleasure for Western investors in directing their interest towards private Chinese companies will be in discovering the benefits of analyzing the basics over the long term, which has made a fortune for Amazon in the West. It is precisely by adopting a long-term approach that, in the B2B sector, Alibaba has had such success in its diversification into logistics and the cloud, enabling it only now to break even after eight and ten years respectively in these fields. Similarly, in the B2C sphere, the most notable successes in digital franchises are those that have tested the patience of investors, who have been called on to finance, successively, concept products, the building up of user communities, and the monetization phase — only reaching financial profitability in the final phase. Therefore, in the next decade, it is in China that “thematic investment” could fully blossom, dethroning value investing and growth investing so dear to the West.

Huabei Stock Exchange — SIPA PRESS

An indispensable opening up

However, this highly seductive scenario will only be enacted if, at the same time, China discovers the financial markets; if, in complete contrast to its ineffective state-owned banks, it finally creates new financial players that are globally competitive, like the online broker Futu Holdings, supported by the giant Tencent; if it really opens up its finance industry to leading foreign companies, as in the case of the recent cooperation in asset management between Amundi and the Bank of China; if, at last, it agrees to invest in financial software, whose domestic market, according to research analysts at Morgan Stanley, was still only $10 billlion in 2019, i.e. merely the IT budget of the US investment bank JP Morgan!; if it continues its truth-operation on the debt of “zombie” companies — in which, in 2020, Evergrande, Tsinghua Unigroup and Brilliance were but the first canaries down the mine; and, finally, if the pilot region of the “Greater Bay Area” really makes it possible for mainland China to adopt Hong Kong’s “rule of law”, which has still been preserved in the business world.

It is therefore obvious that 2020 was just the tip of the iceberg of a swing that might change the global financial world for some time to come. In 2001, the Americans were arrogant enough to let China into the WTO without any pre-conditions, and this led to the industrial decline of the USA. Paradoxically, today, it is the turn of China to show dangerous signs of this same arrogance, as shown by Jack Ma’s insults directed at global regulators.

This is where the West could so easily seize its opportunity. The recent investment agreement between China and Europe makes mention of a far greater opening up of China’s financial services, which proves that, contrary to official propaganda, China recognizes that il will still need us in order to complete the return of Chinese finance to the world stage.



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