URTH - CNYA: Slower Growth But Still Improved Condition Going Forward

2023-04-13 14:43:22 ET

Summary

• China's economy is coming back from hard times during their 3 year severe Covid-19 restrictions, so consider iShares MSCI China A ETF.
• Sentiment is improving in the important real estate sector.
• Manufacturing will evolve and China is still going to be a lead supplier.

Investment thesis

In our previous analysis on BlackRock's iShares MSCI China A ETF ( CNYA ) back in January, we continued our optimism on China’s economy after they finally returned to some form of normalcy after nearly three years of the pandemic.

Finally, they figured out that we have to live with it.

This exchange-traded fund ("ETF") tracks the Chinese market well, and although we have seen volatility over the last year, the share price is down 9.3% against the SPDR® S&P 500 ETF Trust (SPY), which is down 7.7%, so there is not much difference.

However, in this analysis, we want to concentrate on the long-term trends rather than short movements in share prices.

What matters most for China’s economy?

Real estate

During the height of the pandemic, many real estate developers faced financial difficulties which cascaded into buyers not getting deliveries of homes yet having to keep up with their staggered payments to them.

Some confidence in the real estate market is slowly improving.

The average price of a new home in 70 medium and large cities in China reversed the trend of lower prices over 18 months by going up 0.3% in February, according to data released by China’s National Bureau of Statistics.

In periods of crises, the cream will always rise to the top, which reminds investors how important it is to only invest in quality companies.

According to a recent article in SCMP, the state-owned, and a few quality private, developers like CR Land ( CRBJF ), Coli, Longfor Property ( LGFRY ) and Yuexiu ( YUPRF ) have posted sales growth of more than 70% Y-o-Y.

This starkly contrasts sales from troubled developers like Times China ( TMPPF ), Sunac China ( SCCCF ), and Zhongliang Holdings where sales have plunged 50 to 60% Y-o-Y as homebuyers are reluctant to buy from them.

Financials

Closely tied in with real estate comes financials, as they are both interdependent.

Let us first look at traditional banks and insurance companies.

The whole world was made aware of the bank run on SVB and Silvergate Bank in California. Other cracks appeared when weak banks such as Credit Suisse Group AG (CS) were taken over by UBS. Some panic took place amongst those that asked themselves who is next.

The large state-owned banks in China were not affected by this. However, China did see similar problems last year with some of their smaller provincial banks. Just like what we described with customers choosing poor-quality real estate developers, the same goes for choosing a bank to entrust your money with.

The top 5 banks in China, which also happens to be amongst the largest banks in the world are well-funded and profitable.

China’s financial markets are evolving rapidly and as a result, it is offering both the local population and the rest of the world more opportunities to part take in the economy there.

Traditionally, Chinese people have this love affair with real estate and this had led to many wrongfully thinking that it was a “sure win” thing.

Over the long term, the values of real estate tend to go up, but it is cyclical. The last couple of years has been a wake-up call for many as developers were unable to deliver on their promises which led to thousands of unhappy investors.

We believe that this will lead to more informed people looking at investing in other alternatives such as shares, insurance products, and mutual funds.

In a paper published by the Journal of Financial Economics in August 2022, we learned that according to the 2019 yearbook of the Shanghai Stock Exchange, there were 213.8 million individual investors in China. That is 15% of the population.

In Jamie Dimon’s letter to shareholders of 4th April 2023, he stated that more than 100 million people in the United States own stock. That is 30% of the population.

Some of that difference lies in the retirement plans. As the burden of taking care of an aging population becomes larger and larger, China will most likely also shift much of this responsibility over to the population. This will lead to more funds in the financial industry which will invest in the stock market. On top of that is the fact that funds that track global stock markets, such as iShares MSCI World ETF ( URTH ), now hold 67.8% of the portfolio in U.S. stocks and a negligible position in the second largest economy in the world - China. This will most likely change over time.

In our opinion, all this bodes well for share prices in China in the long run.

Manufacturing

We see a glimmer of optimism in the manufacturing sector, with the PMI finally going above 50.

Will China lose its status as the world’s factory floor?

Some have argued that China will no longer be the world’s number one manufacturing nation. This notion became popular during the pandemic as it caused severe difficulties in many companies' supply chains.

China is exporting more than just T-shirts and washing machines. We all automatically think of the things they sell in Walmart Inc. ( WMT ) as what China is exporting. Cheap and uncomplicated consumer goods. That was how its success got started, but it is moving up the value chain.

Millions of people still work in manufacturing and we have reported earlier that China has a high unemployment rate among the youth. The latest figures from December last year showed that the unemployment amongst young people aged between 16 and 24 was 16.7%

Just this year alone, 16.6 million will enter the job market for the first time. As many socialist countries do, governments increase hiring more graduates, but the private sector still needs to do the heavy lifting too.

China is now revitalizing its vocational education by teaching the youth new skills involving technologies like robotics. This is to entice more youth to look for jobs in manufacturing.

• Exports of automobiles.

If you are as old as I am, you have experienced dominance first by American car manufacturers just after WW2, followed by Europeans, then the Japanese and Koreans.

Now China wants to get in on the action too.

In 2022, China overtook Germany to become the world’s second-largest exporter of cars by volume. The growth in export was nearly 57% last year.

• Electric cars and their batteries.

You might have bought an electric vehicle ("EV") from Tesla, Inc. or one of the large European or Asian brands like Audi or Hyundai, and there is a good chance that the batteries in that car were manufactured in China.

According to Visual Capitalist, as much as 33% of the world’s EV batteries come from the Chinese company CATL which provides lithium-ion batteries to Tesla, Peugeot, Hyundai, Honda, BMW, Toyota, Volkswagen, and Volvo. It expanded its market share from 32% in 2021 to 34% in 2022.

They have a world-leading position in making lithium-ion batteries.

Risks to the thesis and conclusion

Geopolitical risks are a concern. Tension around Taiwan seems to escalate and in a worst-case scenario, China could invade Taiwan. This will, at best, most likely lead to potential trade embargoes from the West, similar to what we now see with Russia.

We see the probability as low. Nevertheless, it is still a possibility.

There are concerns internally in China on what President Xi Jinping means when he claims they want to implement “common prosperity.” The older generation still remembers how Mao Tse-Tung did this.

During the 14th National People’s Congress in March, President Xi shared his thoughts on pursuing common prosperity. In his speech, he said:

Be rich and responsible, be rich and benefit others, be rich and loving.”

It sounds a lot like what the Democrats in the U.S. are saying, too.

Chinese leaders understand that it is a challenge to reach their economic targets, such as GDP growth, curtailing inflation, and stabilizing job markets and interest rates. To do this, they will need the private sector of business to grow.

In China, more than 80% of urban employment is created by the private sector.

They will not kill the goose that lays these golden eggs.

We maintain our Buy stance on iShares MSCI China A ETF.

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