Why we believe China’s strategic reorientation changes the case for investment rather than removing it, and also highlights the growing diversity of opportunity in the rest of Asia.

Today’s CIO Weekly Perspectives comes from guest contributor YT Boon.

When Ant Group’s initial public offering was suspended in November last year, few investors sensed that it was the start of broader and deeper legislative and regulatory change in China. Only in the last few months has it become clear that a major policy shift is underway.

Be it for “common prosperity,” a higher birth rate or widespread domestic consumption, such centrally directed policy change is nothing new for China. Back in 2001, the focus was on infrastructure and capital spending to build a developing economy, and Telecoms, Oil & Gas, and Financials stocks boomed. In the 2010s, policy shifted toward consumption and services, giving rise to the Chinese e-commerce, social media and internet-based food delivery giants we know today.

Now, as China moves further up the value chain, policy is shifting from encouraging consumption and internet services to supporting higher-quality industry and advanced manufacturing. This includes electric vehicles, renewable energy, the industrial application of the Internet of Things (IoT) and, above all, the highly strategic semiconductor industry.

Local Champions

We see losers implied by this policy shift. We have seen stocks in sectors such as gaming, e-commerce and even tutoring getting hit. At the beginning of this year, this is where our thematic Research team was focused in China: companies like Tencent and Alibaba, the major e-commerce names and internet content providers, from gaming to livestreaming.

Does that mean we are looking to allocate away from China? No. Rather, we see this as a reason to reallocate within China, to those sectors and stocks that we consider likely beneficiaries of the new policy shift.

In particular, our existing global focus on the 5G Connectivity and renewable energy themes is likely to become a much more prominent feature of our approach to China. These are key enablers of the new policy focus, which will likely warrant industrial automation, IoT machine-to-machine communication and more efficient power sources. The government’s aim of self-sufficiency in hardware, and particularly semiconductors, potentially creates further attractive opportunities in “local champion” chip makers and designers.

Cautious Reallocation

This reallocation may be challenging for investors.

When we made a start, ahead of the government announcements and global headlines that appeared in July and August, we found many local investors moving alongside us. The perceived winners were bid up quickly, and patience has been beneficial: Following disappointing economic data and weaknesses appearing in local real estate markets, more attractive valuations have arisen over recent weeks. We continue to advocate a cautious approach to reallocation as long as regulatory uncertainty remains high.

We think it’s also important to remember that there are plentiful Asian investment opportunities, not only in the industrial automation, IoT and 5G themes—think of the world-leading Japanese robotics and Taiwanese semiconductor and hardware companies—but also in the more consumption- and internet-related themes that are now taking a backseat in onshore China.

Diversity and Global Reach

We think countries like India or Indonesia are the places to look out for Asia’s new Alibabas, for instance. They are at the stage of economic development that China went through 10 or 20 years ago, and digital penetration remains relatively low—but we are already seeing the emergence of local and regional “Super Apps” for mobile banking, ride-hailing, e-commerce, food delivery and mobile gaming.

We also think investors can benefit from embracing Asia’s increasingly global cultural innovations. Yes, South Korea is a well-known hub for semiconductors. But it is much better known by millions of fans around the world as the epicenter of K-pop and mobile gaming. A single online concert by boyband BTS can reach more than 100 million viewers across virtually every country in the world, pulling in tens of millions of dollars for online subscriptions, merchandise, exclusive content and interaction for its parent company: The combination of fandom and faster connectivity around the globe appears to be a big and fast-growing business.

In short, there is no denying that Asia’s largest economy is undergoing a cyclical slowdown and a strategic reorientation. But we believe that implies new sources of “Industry 4.0” investment opportunity within China, while the growing diversity and global reach of businesses in the rest of Asia mean that its economic path is no longer so strongly determined by the regional giant.

In Case You Missed It

  • NAHB Housing Market Index: +1 to 76 in September
  • U.S. Housing Starts: +3.9% to SAAR of 1.62 million units in August
  • U.S. Building Permits: +6.0% to SAAR of 1.73 million units in August
  • Bank of Japan Policy Meeting: The BoJ made no changes to its interest rate targets
  • U.S. Existing Home Sales: -2.0% to SAAR of 5.88 million units in August
  • Federal Open Market Committee Decision: The FOMC made no changes to its policy stance
  • Eurozone Purchasing Managers’ Index: -2.9 to 56.1 in September
  • U.S. Initial Jobless Claims: +351,000 for the week ending September 18
  • Japan Purchasing Managers’ Index: -1.5 to 51.2 in September
  • Japan Consumer Price Index: Unchanged in August year-over-year

What to Watch For

  • Monday, September 27:
    • U.S. Durable Goods Orders
  • Tuesday, September 28:
    • S&P Case-Shiller Home Price Index
    • U.S. Consumer Confidence
  • Wednesday, September 29:
    • China Purchasing Managers’ Index
  • Thursday, September 30:
    • U.S. 2Q 2021 GDP (Final)
    • U.S. Initial Jobless Claims
  • Friday, October 1:
    • U.S. Personal Income and Outlays
    • ISM Manufacturing Index

    – Andrew White, Investment Strategy Group