Navigating a divided world is increasingly difficult for capital allocators. The 24-hour news and social media that are ubiquitous today make rational and effective decision-making even more challenging. One of the topics often discussed among global allocators relates to China and its role in a portfolio. With geopolitical tension dominating headlines around the world, there’s a natural tendency to insulate a portfolio by reducing exposure in areas with significant perceived uncertainties. However, I would argue that staying invested and exposed to China can pay handsome dividends to an investment portfolio, especially over the long term.
Markets with improving fundamentals and liquidity, while investor sentiment is still weak, are ripe for investments. Conversely, markets with deteriorating fundamentals and liquidity, while investors are still heavily exposed, should be avoided. Asset allocation inevitably needs to consider the macro-environment via a top-down approach; as such, it is better to view the macro environment in cycles rather than through the lens of any specific event. In this context, it is hard to ignore a recovering China and the start of a new market cycle, given the selloff over the past few years. In fact, every time over the past 30 years that the China market has gone through a significant downturn, a prolonged bull market (lasting on average 4.5 years) has always followed. General investor sentiment towards China is still depressed, yet this forms a good basis to stay exposed or increase investments.
Despite the economic slowdown in China, investment opportunities still abound. Even if China slows down its growth to only 5% this year, the dollar amount of that growth still represents over 30% of global GDP growth. Its USD18 trillion economy is the second-largest in the world and accounts for nearly a fifth of the global economy. There are sectors that are still significantly underdeveloped and will experience substantial growth in the years to come. For example, China currently has fewer than 1/3 of ICU beds per 100,000 people compared to the United States while having over 4x the population. New infrastructure will also continue to drive economic growth as the country modernizes. It currently has fewer than half the amount of railways per 1 million people compared to the United Kingdom and less than a quarter when compared to Germany. The same can be said for motorways, as China has only a third of the amount of motorways per 1 million people when compared to the United States. Traditional infrastructures are not the only ones being prioritized, as the country aims to ensure nationwide 5G coverage by 2025 and build 20 A.I. innovative trial zones before the end of this year.
A senior U.K. official recently visited Hong Kong and it was the first official trip by a senior British official in five years. I was fortunate enough to join him at the Hong Kong British Consulate, where I shared with a group of local executives in the asset management industry the opportunities available for international collaboration. The topic of geopolitical tension and deglobalization was inevitably discussed, and to the delight of many in the room, it was implied that the United Kingdom has no intention to decouple from China. In fact, many businesses are looking to re-engage with China. Such developments echo the actions of many other corporations from the United States that are setting up wholly owned subsidiaries and investing heavily directly in China. There is a divergence between what headline rhetoric states and what private businesses are doing.
While preparing for this discussion, I wanted to understand how many S&P 500 companies derive their revenue from overseas. It turns out that 312 companies within the S&P 500 have more than 10% of their revenue contributed by international businesses. Of those companies that provide a further breakdown of their geographical revenue source, 45% have more than 10% of their revenue contributed by the Asia-Pacific region. Of those 140 companies with significant Asia-Pacific businesses, 54 companies have Greater-China operations that contribute between 2% and 65% of their revenue. The companies with the most business in Greater China are information technology firms such as Qualcomm, Texas Instruments, Nvidia, Intel, and Micron Technology. Certainly, the reported number of companies with Greater China businesses is likely understated, as many do not provide such a breakdown in their financial filings. When we examine each company’s supply chain, the business entanglement between foreign companies and China becomes even clearer. In fact, a recent article in the Financial Times boldly calls Apple a Chinese company. If a full decoupling were to occur, its effect may be equally consequential for the U.S. economy, given that the large American companies in the S&P 500 index account for over 70% of employment and capital investment, and represent over 80% of available market capitalization.
This analysis may be an oversimplification of the matter, but the exercise makes me ponder whether many asset allocation models are still reflecting factors and using assumptions that are based on an era (since the GFC) and environment (low inflation, lower rates, relative geopolitical calm) that are no longer applicable.
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