Words on China's Investment Outlook

Words on China’s Investment Outlook

In this episode of Words on Wealth, CIO Tim Rocks sits down with David Jenkins, Client Portfolio Manager from GQG Partners, to explore China’s evolving economic landscape and what it means for investors. They discuss the property market slowdown, demographic shifts, and policy influence, while highlighting areas of growth in technology and renewables. The conversation also contrasts China’s longer-term outlook with India’s strong, domestically driven momentum and emerging investment opportunities. Tune in now to find out more!

This episode is also available on Apple Podcast. 

Tim Rocks 
Hello and welcome to Words on Wealth. I’m Tim Rocks, Chief Investment Officer. Today we are going to talk ⁓ about China, macro and investing. There’s always a wide range of views on China. I’ve generally been pretty comfortable with it over the last couple of years, but there certainly are different views. And one of the more, shall we say skeptical funds has been so GQG but they will be joining us today to talk through sort some of those issues and we might have a bit of an active debate on it. And joining me from there is David Jenkins, who’s client portfolio manager. So welcome David and thank you very much for your time.

David Jenkins 
Thanks for having me. You’re always happy to talk China, that’s for sure.

Tim Rocks 
Great, well let’s start with the macro before we get into the investing side of things and maybe start with some recent developments. So it does look as though the economy has been slowing in recent quarters. What’s your take on, yeah, what’s been happening recently?

David Jenkins 
It’s interesting the contrast between what’s happening on a macro point of view, but what’s happening in markets. Obviously China’s had a ripping ⁓ year to date, which I guess is part of the reason we’re having this discussion too is why not be in China? When it comes to the macro, it really has taken a new kind of lower leg down during the year. The government’s pulling back on infrastructure spending, manufacturing activities rolling over, which is partly due to tariff uncertainty, but it’s also know, weak domestic demands, there’s oversupply. And then on top of that, you know, you’ve got property prices, which continue to kind of hit new lows. There’s a number of markers you can look at. We don’t mind looking at things like, you know, what’s happening in terms of barge, barge prices. You know, they’ve collapsed over the last four years and they’re a good kind of sentiment indicator on the Chinese Kim’s humor. And they continue to drop down. There’s a number of other markers there too, as well ⁓ You can see it through banks, can see it through consumer spending numbers. There’s a number of data points you can point to which highlight the weakness, particularly on the consumer side.

Tim Rocks 
Yeah. So let’s just dig a bit deeper on the property side. So my kind of broad take is you’re into the fourth year of the correction, which obviously is not great. But if it was going to bring down the whole economy or bring down the financial sector, really affect banking and the like, you would have seen that by now. So it’s not great, but it’s not no longer sort of existential. Do you have a different view to that or what’s your take?

David Jenkins
Well, it’s been possible to predict the bottom of the property market, I guess, as a starting point and ⁓ continuing to go lower ⁓ is partially to, ⁓ you can’t forget what the C and CCP kind of stands for. And even the slogans of the government, is, know, housing is for living, not for speculation. So to see those legs keep going down isn’t necessarily materially opposed to what the government wants over there. And you can see through banking demand that it is impacting the system. You can see insufficient credit demand, know, retail loan growth has been really slow. And even traditional kind of consumer lending banks, say like China Merchant Bank, they’re shifting to corporate asset origination because they’ve seen the weakness in the retail sector, ⁓ particularly in housing and also in sort of consumer demand. So it continues to roll through. And it is affecting the economy. ⁓ But it’s not the same playbook for China. They don’t have the same kind of long-term drivers that you see in a ⁓ Western style setup. And sometimes I think investors expect a Western style reaction, which you won’t see ⁓ from the government or in Chinese markets.

Tim Rocks 
Yeah, I mean, I certainly agree. It’s definitely a drag and the data that shows that apartments are the largest component of consumer wealth and that wealth keeps going down. Obviously, it’s going to affect consumer confidence and spending and that’s sort of that that is still reasonably clear. So it’s definitely still some kind of issue. Now, what about ⁓ if we think about put a five, 10 year lens on things? think about long term prospects? ⁓ You know, the bears and I’m sure this is right sort of talk to the issue of demographics and how that will is a dramatic change really from from the last sort of or the previous 20 years. ⁓ How do you think about the long term say GDP prospects and other kind of macro kind of issues?

David Jenkins 
For us, we like to talk about direction of travel. And if we’re at forward view from a demographic point of view and some other drivers within the economy, that direction of travel is not necessarily positive. And again, China can take a very different direction to Western economies. But the big things that you’ve seen happen, you’re seeing a lot of ⁓ wealthier Chinese citizens leave. ⁓ You’ve seen now the long-term effect of things, even little things like, ⁓ obviously there’s the aging population which comes through the population control they had through the one child policy, you know, going through a period of time. But even that changes the social norms over the long-term where you’ve got families that used to go and live with their daughter. Now the majority obviously had sons and they don’t have that daughter to live with. So it changes the spending behavior and a generational point of view where they’re now saving more because they have to look after themselves because they can’t live with their daughter. Then you’ve got youth unemployment, which obviously is a figure which stopped being published there a very long time ago. All these things will compound over time ⁓ and all of them lean into consumer spending. And if you look at the makeup of the Chinese index, a lot of it is on that consumer discretionary side. So you need a strong consumer in order for markets to be well. Now, you can take a different lens to that and say from a societal point of view, if housing pricing is lower, I think there’d be plenty of Australians that would be comfortable with a housing pricing correction in terms of their ability to have someone to live. But if you’re investing there and you think about then the wealth effects, that’s been the real shift that we can’t see there being a trigger for it to go on a different direction. The time that China was a far more investable ⁓ market was when you had that strong wealth effect, you had that big buildup in the property market. And since then, the shift in either margins or consumer spending, or even multiples associated with that are far, far worse. ⁓ And that is purely because of the direction of the travel, ⁓ both from a company level and overall negative. Now, that doesn’t mean you’re not necessarily going to see GDP growth in China. But the nature of that growth and how investable that growth becomes does not appear to be positive in our opinion.

Tim Rocks 
Yeah, yeah, yeah, I can see that. mean, I think on the next two to three years, it’s whether that consumer can turn around if there can be some kind of incremental improvement in that property market that, you know, creates maybe not the wealth effect you saw in the 1990s again, but at least stemming of the losses that are going on in property and at least some kind of, you know, better improving prospects for wealth.

David Jenkins
flattening out obviously would be better, but the trigger for acceleration seems unlikely ⁓ at present with the demand growth you’re seeing through the market. And that also you see through company earnings. And there’s a real optimism in from, if you look at the benchmark constituents and the companies are expecting to do well, they are expecting a tick up ⁓ in terms of both margins and spending overall, which there doesn’t seem to be any indication that that’s going to happen, but it’s built into a lot of assumptions and multiples of their market.

Tim Rocks 
Yeah, yeah. That’s all been pretty gloomy so far. I mean, there are definitely some really interesting areas in China. You exports have held up this year because China has had such spectacular success in the new areas that it’s focused on things like batteries, electric vehicles and solar, the new three exports, they call them. ⁓ So yeah, there are some pockets of interest. perhaps that, guess my question is, you the economy and the market can be different things. ⁓ And so when you start looking at the Chinese market, as opposed to the economy, ⁓ what are the differences? like what are the challenges of seeing China is a stock market rather than an economy.

David Jenkins 
Yeah, I mean, there’s always that question between your macro drivers and the underlying investment opportunities within any market. And your three points there are an excellent kind of example of areas that have been a national priority for China. You’ve got solar, you’ve got ⁓ You know, your eventually vehicles, maybe infrastructure renewables across the board. All are great examples of what happens in China where it comes a national priority. You build up excess capacity and it’s great for the consumer in the long term. And you can see that, you know, globally now with EVs and the oversupply that they’re sending around to different markets, including our own, where again, it’s great from a price point perspective, but the long term returns, the margins for those companies, they don’t pan out. You see a real push for scale, but without the margin growth there. And that’s, you know, in our views, kind of classic China. You’re almost seeing that again now on the AI front, ⁓ where, know, sort of become a national priority. And you’ve seen a build out to the point where data center utilization is already. The capacity is that it’s too much. They’ve got this distressed asset. So they’re only using 25, 30 % of the capacity of the data centers that have been built. You’ve got, you know, ⁓ far more large language models in market, which are usable. And these are great from a getting consumer and maybe a societal point of view. And, but as an investor, you see this kind of ramp up the scale up, but then profitability kind of falls away. And it’s been the same in all of those sectors, all those particular industries over time. And it’s probably gonna happen here again.

Tim Rocks 
Yeah, okay, so let’s dig into that a bit more detail. So I think electric vehicles is perhaps the example there where ⁓ if my numbers are right, there’s 130 different companies in China making electric vehicles. So even though it’s been spectacular for growth, for exports, actually investing in any one of those individual companies is a real challenge. So I guess that’s what you’re saying, even though those… Those are spectacularly successful for the economy, they’re not good investments.

David Jenkins 
Yeah, the government doesn’t necessarily want to have one or two winners. They want to have a number of companies competing. They’ll scale up to a point and then generally they’ll go too far and they’ll pull back. ⁓ You see it all the time. mean, what you’ve seen from the national team in China recently is they have been buying up the market to a point now where the CCP sort of told them to tone back ⁓ and the market’s almost overheated. You can apply that same philosophy to any of these segments over time as they’ve built things out. It’s a playbook that, ⁓ again, it’s good for the consumer, but it’s not good for the investor. And that’s where you struggle when you’re trying to do those elements. You might see manufacturing pick up in China. You might see whether the numbers are accurate or not is another point of debate. But just because the manufacturing numbers, let’s say they build up, doesn’t mean those companies in particular are going to be profitable as they go for scale and not marginal revenue on the longer term.

Tim Rocks 
Yeah. And then can I just dig in a bit more into one of the other things you said, which is perhaps comparing Chinese and US AI. You mentioned that the data centers in China are full utilization. But I mean, US has spent about what, trillion dollars on data centers in three years now. Surely that’s the same problem going on there and those stocks keep going up. how do you think, perhaps this is broader question, how do you compare ⁓ US tech and Chinese tech as an investor.

David Jenkins 
There’s probably a different focus in the US. There’s a quest for AGI in the US and what that… Sorry, yes. And what that drives is what the path to that has been over time and you see it. So what happens that causes explosion in terms of data centers and large language model development happen between chat GPT-2 and chat GPT-3?

Tim Rocks 
That’s artificial general intelligence. ⁓

David Jenkins 
where ⁓ people at OpenAI went out and said, well, what if we just pump up the size of the model and the amount of compute we use and see what happens? And they saw this exponential sort of growth in the quality of the output. ⁓ They applied that again from three to four, saw the exponential sort of output. And there was this kind of view that, you know, we’re only a few iterations with more compute, with more information going into models to developing AGI. What seems to have happened between chat GPT four and five is that rate of development sort of slowed down. But that’s been the focus in the US where they want to get to the point where these models are smart enough to do their own reasoning to replace people in entirety. Whereas China has been much more focused, partly due to restriction in the amount of compute they’ve had and they’ve been forced to go in a different direction taking much more practical applications of large language models and integrating them through with different pieces, which means their amount of training requirements been lower as well as their inference cost. Now, what I mean by inference cost is like every time you put a query into chat GPT, for example, it sends that query off to a data center that then comes back with your answer. That’s an inference cost and a compute that’s associated to it. In China with the less ⁓ inference ⁓ costing kind of models that they’re using, you haven’t needed the data centers with as much compute because they don’t require as much with the way that they’ve been building out different applications of AI. ⁓ And that’s been their approach. So you’ve seen very quickly as they’ve gone to sort of an inference requirement that ⁓ There’s only so much compute you need with practical applications ⁓ of AI or large language models in general. Where in the US, they’re still very much in that training phase where they’re searching for AGI and putting lots and lots of money into data centers kind of in the middle of nowhere where they’ve got as much compute as they possibly can. So the path to success in the US is buy as much computers as you can, build as big a model as you can, and then we’ll get to AGI. And that’s really what’s been driving the CapEx band in markets overall is once they get to this kind of view of AGI, you can replace people, the amount of efficiency drivers will be massive and it’ll be worth the giant investment that’s being pumped in. Now there’s a number of challenges to all of those theses, which we’re not necessarily going to discuss today, but in China, it’s been less on that path to AGI and more into practical implementation. So the cost hasn’t necessarily been as high in terms of compute investment. ⁓ And now you’ve seen an environment where their compute requirements, data center requirements aren’t as high because they’ve got to this inference phase faster or the inference costs that they have is much lower on these practical applications. So the dynamics are completely different. The investment requirements are completely different. And it is a potential warning to what’s happening in the U S that maybe you don’t actually need the amount of compute or the amount of data centers that are being built out. ⁓ perhaps these practical, ⁓ more practical applications in China are the way to go. And it’s a real different approach to how they’re going on this journey. Now to your broader question and, ⁓ feel free to stop me here. The, the other aspect is around the chip technology which has been a big back and forth where it feels like the US wants China to be reliant on their technology. And then they’ve been restricting the models that are going across all the chip technology to sort of one generation behind. ⁓ So that the technology companies in the US have sort of had a leg up. It’s got to a stage now where chip manufacturers in China will telling the market they’re almost actually at that generation before themselves anyway, in terms of performance. And they may not need the manufacturing, you know, sort of from what’s coming out of, out of U S tech companies. And there’s a lot of back and forth on that at the moment.

Tim Rocks
Yeah, yeah. Okay, ⁓ that’s all been very interesting. ⁓ so then when you think of China, just ⁓ in broad terms, ⁓ if there any perhaps just quickly any sectors that you do like and ⁓ that that you think are interesting at the moment?

David Jenkins 
Well, when we’re looking at things, it’s always on a bottom up basis. So if we look at the names that have been driving performance this year, things like say, ⁓ say a large benchmark weight like BAWA, which has been driving performance. You can look at company like that and you look at what’s driving its return profile. A lot of that’s been kind of multiple expansion. ⁓ What we look for is sort of sustainable earnings growth and sustainable quality factors. There’s a few names on a bottom up basis that we do like in China. But it is a more limited ⁓ set of companies. Ones that have sort of truly differentiated moats around the business is something like a Tencent, which is one company which we haven’t gone back into. There’s some other elements as well, but largely we’ve been staying away from companies which have been driven by… probably AI exuberance. ⁓ And it’s similar actually, if you look at the benchmark kind of year to date, the biggest performers have been ⁓ Korea, Taiwan and China, which are all very much tech led. ⁓ And a lot of that theme globally has been through multiple expansion. Now, to think about where we’re trying to invest in China and trying to focus more on China overall, ⁓ there are some companies which are ex that the other challenge with China is then trying to separate potential government influence ⁓ and trying to negate the negative consumer elements in terms of their return profile. So there are some companies there that aren’t as reliant on a pickup in consumer spending in China. And there’s also ones that seem to be getting left alone from a policy perspective ⁓ from the government, which are the kind of two factors that we’re looking at, ⁓ as well as traditional, know, earnings growth elements that will apply to anything on a bottom-up basis.

Tim Rocks 
Yeah, yeah. And perhaps just finally, just to complete the whole picture. ⁓ If you then if you look across your ⁓ exposures, where are you currently positioned? What are the best opportunities you think at the moment, perhaps just at a country level or a sector level?

David Jenkins 
Yeah. I mean, on a country level, we’ve been overweight in India for a number of years. It’s been our probably our biggest counterweight to being underweight China over the period. And that’s because the runway and headroom for growth in India is quite clear to us. It’s all very domestically driven. see earnings growth continuing to come through. And then our pockets that are in India are actually quite cheap on a relative basis. It kind of always gets thrown out as a being an index, which is too expensive. And there are pockets, which are, but if you look at something like the banking sector, you’re seeing great growth there at reasonable multiples, cheaper sort of than you might see in the U S and the banking components in, you know, places like India or Brazil, for example, you know, they’re trying to true almost like cartel like businesses where you see net interest margins are much, much higher. India sort of trades with NIMS in about four, Brazil’s about 3.8, which are much, much higher than other markets. And if you compare it on the ⁓ landscape, China might be running at sort of one and a half and South Korea, maybe 1.9. So you can see high growth there from, the consumer and commercial side of things, but also large interest margins. There’s good opportunities there for growth in the banking sectors. And we also like utilities across those markets as well, where you’re seeing continued energy demand build out ⁓ more of a secular ⁓ growth story there.

Tim Rocks 
Yeah. All right, great. Well, thank you very much ⁓ for your time, David. That was all very interesting. yeah, good luck with those markets ahead.

David Jenkins 
Really appreciate it.

Tim Rocks 
Thanks and bye.