You will know from my previous columns that I don’t think politics matters nearly as much to investment as we think it does and can often be ignored. One area of the world where this is emphatically not the case, however, is China.
First, let’s step back from the increasingly frenzied talk about superpower stand offs, and potential war scenarios. It’s very easy to work oneself up into a frenzy when examining China’s relationship with the West. But most of the time, those wearing tin hats and warning of the end of the world don’t win the debate (though there are always exceptions).
Arguably, China’s relationship with the US can be characterised as one of competitive tension. Two superpowers struggling economy for dominance, keeping tensions just on the right side of aggression. This could spark a huge technological battle between China and the West which will have huge spillover (positive) effects on productivity and economic growth.
This superpower tech race could be invigorating, if scary and dangerous, but the competitive tension might just stay at that level – and hopefully, China will not invade Taiwan. This more benign scenario is I think a default position and is mapped out very clearly in a recent paper called Forecast 2025: China Adjusts Course from an outfit called the Macro Polo team, based out of the Paulson Institute.
The assumptions made by this report include:
- China’s political economy will remain largely what it is today, ruled by a strong Chinese Communist Party (CCP) led by general secretary Xi Jinping.
- Direct US-China military confrontation is unlikely, but competitive dynamics and tensions will become more explicit and play out across all major geographies.
- Globalisation will likely continue to stall as countries turn more inward and regionalism becomes more prominent.
One person who definitely thinks that we all need vastly increased Chinese technology exposure is the manager of the small Manchester & London (MNL) investment trust. Mark Sheppard has a fair old chunk of how own (and his family’s) money in the fund and has developed a well-articulated world view about why Chinese tech is so interesting.
He starts off with what I think is probably uncontroversial stuff, namely that China will toughen up its control over its people, and stifle Hong Kong’s freedom. One mechanism for greater control will be a new digital currency which gives local fintech giants like Tencent (0700.HK) and Ant Financial even more market power. ‘Good citizens will get a great life and access to loans and investments which will be facilitated through the likes of Tencent and Ant, which will allow them to spend freely (through Alibaba) on achieving a middle-class lifestyle’. China will also push its weight around in Taiwan (avoid all Taiwanese stocks, he says) and re-establish its regional overlord role in the Southeast Asia region.
But the real core of the global challenge is the massive scientific arms race underway. China wants to be number one and everyone else will have to spend a fortune to keep up. Back to the fund manager’s take:
It is going to become increasingly hard for the US to hold back the tide of Chinese tech when offered to such nations when its quality is ever-improving and its pricing is very heavily subsidised. China is graduating 1.3m science, technology, engineering and mathematics students annually versus 300,000 in the US, with China graduating 185,000 computer sciences students annually versus 65,000 in the US. How can it conceivably compete in the future if this continues?
The key part of Sheppard’s argument, for me, is the following:
China has an army of technically educated people, a low-cost production base being driven increasingly by sophisticated automation (which Western unions will not allow) and they have a government determined to win and subsidise their national champions to outcompete the Western competition until they get majority market shares. The story will be repeated across semiconductors, network infrastructure, electronic goods and pharmaceuticals and social media. Those that try to put brakes on their advances will be punished with incarceration of citizens (Canada) and buying strikes (Australian wine and grains, German pork and Norwegian salmon).
And the investment conclusion? According to Sheppard:
The [Southeast Asia] region will end up dominated by China and those Western companies that continue to invest materially in these regions are dooming themselves to low to zero return on invested capital. In time Alibaba, Tencent and Ant will acquire local operators like [Singapore taxi hailing app] Grab (or crush them) and dominate the region. With the expansion of their operations across China and [Southeast Asia] coupled with fast growing personal income for their users we see all three of Alibaba, Tencent and Ant trebling their sales in the next five years, providing some of the most compelling investment opportunities in the world.
In a sense, the payoff is obvious and again one I have also articulated. The technology-driven rise of China might be good for Western investors who will be offered huge returns for investing in China’s rise to superpower status. Remember, China still needs our capital!
Two last quotes from the Manchester & London newsletter are I think dismally true. The first is from Sheppard: ‘The CCP has worked out it does not need to risk a war to win the capital of the West, it will get it anyway.’
The second is from US fund manager Ray Dalio: ‘Empires rise when they are productive, well educated, work hard and behave civilly. Objectively compare China with the US on these measures.’
So, should we investors be looking to build, say, 5% to 20% exposure to Chinese equities? The case against this optimistic argument is equally strong.
Three exhibits. First Australia, which is currently the focus of Chinese ire with a range of exports now choked at customs control. Next up we have the Ant Financial flotation debacle. One week we had what was going to be the global fintech blockbuster launch, the next a humiliating climbdown and ‘postponement’ as local regulators took umbrage with boss Jack Ma.
The last exhibit is the one that makes me really shake my head. It speaks to the brazen willingness of the Chinese government to interfere in other countries’ affairs. It is called the Operation Fox Hunt saga and is playing out in New Jersey. Hat tip to the wonderful Bill Bishop and his Sincocism newsletter. You can see the outline of the case here, but the basics are below.
The US Justice Department has charged eight people with conspiring to work on behalf of the Chinese government to intimidate Chinese citizens into returning to their home country.
The group is alleged to have targeted a former Chinese government official living in the US, harassed his daughter and flown his elderly father, against his will, to the US to pressure his son to return.
It’s quite easy to see these stories, and default into tin hat alarmism. But Western investors have a more mundane question facing them: are we collectively happy to fund China’s rise to superpower status? Do we ignore China and its growth potential and turn inwards, or do we increase exposure to China and technology? My emotional side says we should avoid China, but my coldly rational side says we need to invest more. What’s your view?
David’s daily blog is available at www.adventurousinvestor.com.
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