BEIJING’s wide-ranging policy changes have rocked confidence in markets in recent weeks, but all the noise about internet regulation and video games is masking an even deeper problem for investors — a rapidly slowing Chinese economy.
That’s the view of James Syme, who co-manages Pendal Global Emerging Markets Opportunities Fund.
A slowing China has serious ramifications for emerging markets, with many economies reliant on Chinese demand for their commodities and goods, says Syme.
China’s most recent economic indicators paint a picture of a sharply deteriorating economy. Indicators as wide-ranging as retail sales, property investment, industrial production and money supply are all weaker and below expectations.
“Normally when you have a set of economic data that’s trending one way, there are a few outliers,” says Syme.
“What’s quite surprising about the Chinese data through July and August is its consistency.”
“We’ve consistently been saying that we should expect a Chinese slowdown given the tightening of monetary and fiscal policy in the first half of 2021, and we continue to have that kind of cautious stance with China,” says Syme.
“You can definitely say that the Chinese economy now is weaker than it was at the start of the year.
“The real implication is what does this mean for emerging markets that are dependent on China?”
Two important China-dependent emerging markets are Brazil and South Africa.
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Perhaps surprisingly, Syme maintains a relatively positive views on both.
“How can you have that view on China and yet still be positive on Brazil and South Africa? The answer is domestic demand,” he says.
Syme says GDP growth in Brazil is forecast at 2.2 per cent for 2022, while South Africa is forecast to grow 2.3 per cent, “so we’re not talking about strong growth”.
But the normalisation of domestic demand as the economies emerge from the COVID pandemic should underpin the local stock markets and provide opportunity for investors.
“That’s the general pattern that we’re focusing on even if commodity prices come down,” he says.
Still, there are domestic risks to watch.
Brazil goes to an election next year which brings the threat of a market unfriendly outcome echoing political instability elsewhere in Latin America.
Meanwhile South Africa is struggling with social unrest and violent protests.
“It’s likely to encourage the government to provide more support to people in distress, which would be positive for domestic demand. But you have to be aware that the longer conditions remain difficult the more there is political risk.”
Among other markets, Syme says Taiwan and South Korea face risk from the Chinese slowdown as they export to China and will suffer slowing demand. Indonesia will bear lower commodity prices for its exports.
India will be a net winner as the Chinese slowdown reduces the prices of commodities that India imports. Russia will lose some pricing on its metals exports but remains largely a play on the oil price.
Syme cautions against conventional wisdom that Beijing will step up with stimulus as the slowdown continues.
“If you think about what Beijing is trying to do, it’s to rebalance the economy. That means more consumer spending and services, and less construction,” says Syme.
“It’s hard to put an exact number on it but construction is about 20 per cent of GDP in China, and including related industries, it’s probably more like 25 to 30 per cent.
“There’s this focus on internet and education stocks and video games, but the copper price is at a record $9400 a tonne – that just does not make sense in the light of where the economy is at.”
James Syme is a senior portfolio manager of Pendal’s Global Emerging Markets Opportunities Fund with Paul Wimborne.
The fund aims to add value through a combination of country allocation and individual stock selection.
The country allocation process is based on analysis of a country’s economic growth, monetary policy, market liquidity, currency, governance/politics and equity market valuation.
The stock selection process focuses on buying quality growth stocks at attractive valuations.
Find out more about Pendal Global Emerging Markets Opportunities Fund here.
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