Local investors need a new playbook on China

China’s slowing GDP growth and transition away from an infrastructure investment-led to a consumer-led economy, while also having fiscal implications for SA, is increasing risk for local investors and requires a nimble approach from asset managers.

The old investment playbook — which relied on China’s multiyear, near double-digit economic growth, investments into infrastructure and property, and global manufacturing dominance to sustain it — is no longer relevant.

Instead, China’s economic growth headwinds continue to be splashed across front-page news with headlines such as “Xi’s failing model” and “China’s fading economic miracle and disillusioned youth”.

Rather than dominating global growth through 2023, as hinted at by the IMF in the first quarter of 2023, China is floundering under an alarming debt burden and changing demographics.

Underestimated economic implications

Given the size of China and its importance to SA,, more attention needs to be paid to China’s economy than the US.

The macros that have driven the Chinese economy over the past two decades are unlikely to continue to drive it over the coming years, and that has significant consequences for SA. 

China is facing some fundamental structural issues, starting with its demographics.

In the 1970s, the country boasted a near-perfect balance between young and old. Today the pyramid is all askew, with an ageing population and a low birth rate. There are fewer workers to power the manufacturing sector and no-one to buy the thousands of homes built during the debt-fuelled property boom.

China’s property sector, long an underpin of its economic growth, is faltering. At its peak, it made up 32% of GDP, while today it’s at levels last seen in the early 2000s, at about 24%.

Property as an investment vehicle is now being questioned in China. In addition, its economic model now needs to change from being manufacturer intensive to consumer intensive.

These changes will have a significant impact on SA investors, given that about 35% of JSE top 40 revenues derive from Asia and the Middle East. 

Commodities conundrum

China is one of SA's major trading partners, but a waning economy has a far greater impact than simply affecting our trade balance.

At present, Chinese demand for major commodities such as aluminium, copper, iron ore and nickel make up more than 50% of global markets.

Any fall in demand for commodities is bad for producers such as Australia, Chile and SA. In SA's case, a slowdown in Chinese commodity demand — and decline in commodity prices — results in a drop in export revenues and tax revenues. 

The contribution of commodities to SA's income tax and royalty revenues is starkly illustrated by the tax contributions of the 15 largest mining companies.

Their tax contributions are forecast to fall by almost half in 2023, from R90bn in 2022 to about R48bn (and well short of the 2021 windfall of R110bn). The story worsens in 2024, with a further 10% decline in estimated tax revenue collection to just over R40bn.

However, the SA revenue authorities are not the only ones feeling the commodity price pinch. Playing China through the resources companies is going to become less relevant and less profitable.

Over the past five years, the best way to earn returns through the JSE (as affected by China) has been via the resources sector, but a slowdown in China’s motor vehicle manufacturing and property investments and the “shift to green” are forcing a rethink. 

A new approach is needed, with companies such as Naspers and Richemont being more likely to dominate future “plays” on the Chinese market. This is because firms with exposure to the Chinese consumer theme are preferred over those exposed to resources as they will benefit more from the transition away from infrastructure-led growth. 

Selective opportunities

If you look back over the past 40 to 50 years, you see plenty of bad news-driven pullbacks, yet our market has delivered returns amid this noise through the decades.

This indicates that opportunities for returns still exist for the selective investor.

Against this backdrop, Old Mutual Investment Group's preference is for a cautious equity strategy, with a higher weighting to gold and global defensive and technology shares, and a move away from resources and telecom. 

The focus is on finding firms that will prove resilient, regardless of the macroeconomic constraints.

For shares with global revenues the likes of Anheuser-Busch, British American Tobacco, Naspers and Richemont are on the radar.

As for SA Inc, local banks remain attractively priced, as are defensive retailers such as Spar and Shoprite and clothing retailers such as Foschini and Mr Price. 

This article was sponsored by Old Mutual Investment Group.