A shifting landscape – Assessing China's reopening

Catherine Yeung, Investment Director, and Marty Dropkin, Head of Equities, Asia Pacific, joined forces with Evelyn Huang, Multi Asset Portfolio Manager, and Lynda Zhou, Equity Portfolio Manager, to explore the ramifications of China's swift reopening on its growth trajectory, manufacturing sector and potential investment opportunities. With an additional contribution from James Trafford, Analyst and Portfolio Manager. 
 
The pandemic certainly caused disruptions to manufacturing and logistics operations, but there have also been longer-term pressures at work. Even before the outbreak, geopolitical risks prompted companies to seek new markets for their products and shorten supply chains – a trend accelerated by the US-China trade tensions. In addition, demographic shifts are increasing production costs around the globe as businesses scramble to remain competitive. 

The cost of business diversification 

The reshuffling of supply chains has “definitely increased near-term inflationary pressures on companies,” says Huang. According to a survey by the US-China Business Council, more than 20 per cent of US businesses with a footprint in China are considering moving at least a portion of their operations to other regions due to ongoing US-China trade tensions. “You are potentially shifting your manufacturing hub to higher-cost regions and countries. This is not just about wage bills, but also electricity and infrastructure,” she explains. Taking a longer-term perspective, globally competitive companies will inevitably diversify as tensions remain. “This is a strategic move that companies must bear,” she says.  

Assessing the cost of globalisation

“The biggest challenge we have in China,” says Zhou, “is sourcing from overseas markets.” For instance, the shipping hangover was of particular concern in 2020 and 2021, leading to an increased effort being dedicated towards domestic procurement. However, this does not mean China's globalisation strategies must be put on hold; it can still successfully rise up value chains due to emission concerns, labour costs and access to talented graduates – meaning those days when China was viewed as a low-end manufacturing hub are over. Zhou affirms that "from the supply and demand sides, domestic manufacturers can improve their positions in the supply chain.” 

Opportunities as corporate spending increases 

Zhou sees further opportunities in companies using capital expenditure to expand. “It corresponds with the globalisation trend,” she says. Specifically, she points out how the correction in the new-energy and electric vehicle (EV) chain has also made some stock valuations attractive. On the other hand, she cautions against investing too heavily in exporters with significant US or European exposure due to a potentially challenging outlook in 2023. 

The impact on the broader region 

While China’s EV industry is booming, Indonesia and Thailand have a unique opportunity to benefit from the demand for outsourced components. Trafford states that “the opportunity for Indonesia is on the battery side – a critical component of EVs and a significant proportion of the cost.” Indonesia has abundant natural resources crucial for manufacturing batteries, like nickel (the world’s largest reserves), cobalt and manganese.  
 
In addition, one sizeable Thai manufacturer has announced plans for a US$500 million investment in new facilities with an expected output of up to 150,000 vehicles annually starting in 2024.1 “Thailand is confident that there’s a solid, healthy pipeline of indicative interest from Chinese EV supply chain companies looking to relocate,” notes Trafford.  

Bridging the technology gap 

Semiconductors are also in focus. “It is easy to imagine that the US ban on semiconductors to China would be good for domestic supply,” says Zhou. But she points out a technological gap between the US and China. “It’s probably a lose-lose situation for both countries,” she says. In the past, we had the combination of a large market in China and advanced technology in the US. “It created a positive spiral that boosted development. Yet, it looks like this trend will be reversed in the next decade,” she continues.  

Service to the economy – the rebound in consumer activity

From an investment perspective, pent-up demand could trigger a consumption-led economic upturn. According to Huang, “Defensive sectors tended to outperform last year, but since November and December, services and consumption-related segments have rebounded.” An estimated US$877 million worth of savings could ease the pent-up demand from Chinese consumers.2 “As such, the market could still have some room to run,” she continues. 
 
For investors, sector allocation and a focused stock-picking approach may be more appropriate in the current market. However, Yeung says, “Despite any near-term challenges that surface, China still presents a compelling opportunity for long-term returns.” 

Sources:
1: Fidelity International 2023
2: Ibid