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Will the Year of the Rooster turn out to be Year of the Bear instead?

Saturday 28 January is Chinese New Year, which will see the commencement of the Year of the Fire Rooster according to the Chinese zodiac. With this in mind, now is a time that many investors may be considering the prospect of investing in the world’s second largest economy.

Jason Hollands Jason Hollands
27 January 2017

Don't get dazzled by big GDP numbers

In our view, while there are undoubtedly long-term investment opportunities in China, there are plenty of reasons to be cautious too.

With a population of around 1.37 billion people (representing 18.5% of the global population) and a rapidly growing economy, it would be easy to think China is a must-have accessory in an investment portfolio.

However, it’s important not to confuse GDP growth with stock market opportunities – there is no direct correlation between Chinese GDP returns and those of its highly volatile stock markets. After all, you cannot invest in “GDP" and in the case of China much of its economic growth is uninvestible, representing items such as state-orchestrated infrastructure investment activity.

To a degree, you can invest in securities markets, but these have a very different make-up to the Chinese economy and what makes up its growth figures. For example, some 27% of the MSCI China Index is represented by financial companies such as banks and 32% by IT companies. While China is undoubtedly a huge economy, be aware that its share of global equity markets (as measured by the FTSE All-World Index) is just 2.2% – which compares to the US (53%) and UK (6.2%).

China's demographics are set to deteriorate

China’s population is expected to peak over the next decade and the workforce is already shrinking –the number of workers aged 16-59 dropped by nearly 5 million in 2015. The prospect of a large but ageing and declining population has some parallels with Japan, which has been shunned by many investors on the basis of its poor demographics.

Ballooning debt

China’s debt has grown rapidly as a means of financing economic activity to sustain its target rate of 6.5-7% GDP growth. In 2016 alone, China saw credit expansion of 16% more than the previous year and non-financial sector debt has expanded by almost 75% over the last year. Total debt growth now stands at around 2.4 times China’s GDP. This has prompted the Bank of International Settlements to warn that China could face a financial crisis within the next three years.

A China-America trade war?

With President Trump instituting an “American first” approach both in matters of trade and foreign policy, he has already accused China of being a currency manipulator, threatened steep import tariffs on Chinese goods and has cast doubts about the continuation of the settled US policy of not-officially recognising Taiwan, which China regards as a rogue province.  This has led to heightened concerns about a trade war between the US and China, which on a relative basis, America would likely win.

Investing in China

For most investors, exposure should be through broader Asian and Emerging Markets funds that can partially allocate to China and weigh up the case against other opportunities, such as India, rather than specialist China funds that are going to be more exposed to the risks.

Similarly, investors do not need exposure to companies listed on China’s local stock markets to get a piece of the action. There are plenty of developed market companies (and funds) that are tapping into China’s potential but are on liquid exchanges such as in London, where high standards of corporate governance and transparency are required. UK-listed firms such as ARM, Burberry and Unilever all have exposure to China. Global funds, such as Scottish Mortgage Investment Trust include holdings in key “new China” companies such as Tencent, Baidu and Alibaba.

So, whatever surprises the Year of the Fire Rooster brings, tread carefully when it comes to China funds.

For more information about our investment views please get in touch on best@bestinvest.co.uk or 020 7189 2400.