Head of Asia ex Japan equities
Trade is expected to remain a lightning rod for US-China relations, and while the Covid-19 situation has been under control in China, pandemic-related uncertainties persist globally. Unknowns about how these developments will play out can be a potent source of investor anxiety and market volatility in Asian equities.
As bottom-up investors, we choose to look past the news cycle and focus on what’s driving company performance to guide our investment decisions. As China’s recovery continues and benefits the rest of Asia, we see three important trends that may have significant implications on Asian companies and may influence our Asia small cap positioning going forward.
Resiliency amid adversity
Even with the twin threats of the trade war and the coronavirus, Chinese companies with strong business models continue to gain market share due to their operational efficiencies and ability to align closely with customers. For example, one small cap company we’ve been following, a Chinese textile manufacturer for a leading global brand known for simple yet stylish and affordable clothes posted solid earnings in the first half this year despite the sudden drop in demand during the lockdowns. Exporters like this tend to have already diversified their manufacturing centers outside of China in prior years – a move that helps reduce their exposure to US tariffs and any production disruption in China.
Chinese suppliers have yet to be knocked from their perch in global supply chains, primarily because of their economies of scale and ability to diversify locations and control costs through automation.
This trend also benefits a number of Southeast Asian countries to grow into the next manufacturing centers, as Chinese exporters that have relocated or plan to relocate some of their manufacturing capacities to these countries bring their capital, experience, and knowledge over.
China’s Share of Global Exports Still at All-Time-High Levels
Source: Standard Chartered, Bloomberg, PineBridge Investments calculations as of 30 September 2020. For illustrative purposes only. We are not soliciting or recommending any action based on this material.
Continued R&D spending
China’s faster recovery from the coronavirus could allow the country to further accelerate research and development (R&D) spending versus the US. Total R&D expenditures last year rose more than 12%, the fourth straight year of double-digit growth.1 At the micro level, we find that Chinese companies that continue to invest in R&D and technology, thereby increasing barriers to competition with better products and more efficient production, also continue to gain global market share despite a difficult market. And just like during the global financial crisis in 2008, we see cash-rich companies, including in the small cap space, seeking M&A opportunities at distressed prices amid the Covid-19 crisis.
China’s R&D Expenditures Have Been Accelerating
Source: Ministry of Education, UBS Estimates, as of 30 September 2020. For illustrative purposes only. We are not soliciting or recommending any action based on this material.
Perhaps one of the more lasting trends arising from protectionism is the push toward greater Chinese self-sufficiency – in particular, producing high-tech components domestically rather than importing them from the US amid sales restrictions. We believe that over the next three years China will climb up the technological ladder. The government has already set a goal of becoming a global artificial intelligence powerhouse by 2030, and Chinese telecom companies have led globally in terms of 5G implementation.2 China also aims to boost semiconductor self-sufficiency to 70% from 30% in 2019 with the government offering tax cuts and incentives to chipmakers to increase local production.3 We are keenly watching developments in China’s tech sector and its broader ecosystem to identify and capture overlooked opportunities in this dynamic environment.
Expected Contribution to Growth from China’s Investment in 5G
Source: China Academy of Information and Communications Technology, as of 30 September 2020. For illustrative purposes only. We are not soliciting or recommending any action based on this material. Any opinions, projections, forecasts, or forward-looking statements presented are valid only as of the date indicated and are subject to change.
Strong domestic demand in China is likely to keep the country’s post-lockdown recovery going, and we see its cascading effect on companies across Asia that are catering to this demand and already showing improving sales.
But as we have underscored previously, the sustainability of this recovery depends on Covid-19 being under control. Thus, conditions may remain tenuous until effective vaccine or therapeutics are widely available. Over the long run, however, the diversification of manufacturing bases and localization may bring about fundamental shifts in the Chinese economy, with a corresponding set of new opportunities arising in China and across Asia for discerning investors.
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1 Source: National Bureau of Statistics, the Ministry of Science and Technology, and the Ministry of Finance, as of 27 August 2020.
2 Source: https://www.cnbc.com/2017/07/21/china-ai-world-leader-by-2030.html, as of 21 July 2017; Global System for Mobile Communications Association (GSMA) data as of 17 March 2020.
3 Source: https://global.chinadaily.com.cn/a/202008/20/WS5f3de353a3108348172618ec.html, as of 20 August 2020.
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