Headlines scream daily about the “trade war” between the U.S. and China, spurred by real and threatened tariffs and fitful negotiations. These are not small issues, given that the U.S. accounts for almost 25% of global gross domestic product (GDP), and China is second at around 16%. The longer it lasts, the bigger the impact on these and other economies – and their stock markets.
Who pays for trade wars? At the end of the day, everyone pays. Everybody seems to be invested in U.S. equities, U.S. bonds and U.S. currency. If that trend reverses – as it did in 2002 and 2003 – it would be a very powerful move for international equity and bond markets.
Yet focusing on these macro conflicts crowds out a key story driving investment opportunity: Chinese consumers are doing well, better than ever, even as many investors overlook them.
We are growth investors. When moving beyond the U.S. and other developed markets, investing in emerging markets (including China) generally brings with it more volatility. We constantly ask: is there enough upside in terms of growth to make the increased risks worthwhile?
Growth in China is not particularly overpriced; it’s actually pretty well priced. That growth can continue for a long time because of the structural changes occurring in the Chinese economy – chiefly the growing strength of the consumer – and the market is not pricing for that at this point.
Many of the companies that serve the rising Chinese consumer class are doing very well. This leads us to be comfortable with names like Alibaba and Ping An Insurance. They can grow for a long time, a case we cannot make as well for other parts of the world. The volatility these stocks bring into our portfolios has not been not particularly destabilizing. The Chinese consumer also travels and is a big spending force in Japan for companies like cosmetics maker Shiseido and for luxury brands such as LVMH.
The Chinese economy is nuanced in terms of what is growing, what is not growing, and what is really impacted by trade issues. To offset damage from American tariffs, China incorporated massive stimulus measures, spread over 2018 and 2019, in absolute terms the largest it has ever done: roughly 5.6 percent of GDP. It is sometimes forgotten because the Chinese economy continued to grow during that time.
One of the most important moves was bringing down the reserve requirement ratio for banks, allowing them to lend more with their existing capital to business and retail customers. It is a powerful tool, but it takes time to filter through the system, and it worked well.
The Chinese primarily targeted encouraging liquidity in their banking system and financial markets, which is very important to fostering economic growth. What is less well known is they also issued special government bonds – and gave tax cuts to their consumers.
A lot of growth within China is not necessarily linked to GDP growth, so many developments in China will be relatively insulated from the tariff squabbles. In the short term, though, sentiment can impact markets, specifically the stock performance of some of the traditional state-owned enterprises: they are more levered, so they can be more worrisome.
China is trying to grow quickly in areas where they have little expertise, like developing their own pharmaceutical industry. This has led Chinese consumers to reorient and start spending in meaningful ways in areas where they have not traditionally spent, such as cosmetics and skincare. New business models are being developed around the cloud and e-commerce.
If the trade war gets fiercer, China will do further stimulus, without any doubt. They also will most likely devalue their currency, which could be a little bit ugly for the rest of the world.
Thus, as go prospects for Chinese consumers, so too go the prospects for investors in Chinese consumer equities.
Elisa Mazen is a portfolio manager at ClearBridge Investments, a subsidiary of Legg Mason. Her opinions or the mention of any particular security are not meant to be viewed as investment advice or a solicitation for investment.
All investments involve risk, including loss of principal.
© 2019 Legg Mason Investor Services, LLC. Member FINRA, SIPC. Legg Mason Investor Services, LLC and Western Asset Management are subsidiaries of Legg Mason, Inc."
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