A fortunate outlook for China

Newly opened from its COVID-19 lockdowns, two tailwinds are in place which are making China a more appealing investment option for Australian investors.

Both tailwinds relate to the Chinese government opening up and relaxing its stringent oversight, both at domestic and international levels.

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The first of these concerns a more cooperative conversation between Australia and China in its trading relationship, while the second indicates a loosening of strict rules governing its major technology companies after a three-year long crackdown.

A more open trading relationship

In a sign that Australia is relaxing and welcoming more open relationships with its trading partners, Treasurer Jim Chalmers met with his Chinese counterpart, Liu Kun, at the G20 Summit in India on 18 July. This was the first time the two roles had met in four years. 

During the meeting, the pair discussed the trade restrictions currently in place on certain Australian exports such as barley and wine. China is Australia’s largest trade partner but in 2020, several trade sanctions were imposed after the then-prime minister Scott Morrison angered China with comments about the origin of COVID-19.

While some sanctions, such as those imposed on Australian fruits, have since been lifted, others remain in place with no end date in sight. On 4 August, it was announced that China will remove duties on Australian barley which the Australian government said “affirms the calm and consistent approach” it has taken with China.  

Joseph Lai, chief investment officer at Ox Capital Management, said: “It was good for them to meet each other and it reflects a change in tone from China and a greater desire to stabilise relationships and work together. They are open to cooperation.

“China is the world’s second-largest economy and countries want to have a stable trading relationship as the alternative is rather unsettling and negative if relations worsen.

“If relationships between Australia and China can be stabilised, then there would be little reason for trade to be negatively impacted. There is a huge market for what Australia can provide.”

Compared to pre-COVID, the volume of exports to China is now consolidated in different sectors with more focus on commodities related to the climate transition and electrification rather than for construction materials.

“The economy has strong, long-term prospects and going forward, the domestic market is much more consumption-focused. They are still importing commodities but in much smaller volumes. Instead, they are looking at commodities such as copper, nickel and lithium, and Australia is well-placed for that.”

In addition to Chalmers’ visit, Prime Minister Anthony Albanese has also received an invitation to visit President Xi Jinping in China but it is not yet confirmed if this will go ahead. 

A conclusion of tech crackdown
The second tailwind for China is the lessening of a regulatory crackdown on technology companies, which began suddenly in 2020 as a way for the country to crack down on the power of tech companies. 

Among the said actions included the pulling of a planned IPO by Ant Group after Alibaba founder Jack Ma was seen as being critical of the Chinese Communist Party.

Magellan was among the fund managers who were expected to participate in the IPO, which was to be the largest in history when it listed in the US, and would have been its 12th largest shareholder. 

Former chief investment officer, Hamish Douglass, described the decision to hold an 8 per cent weighting to Alibaba prior to the IPO as a risk management mistake that was due to “overconfidence and confirmation bias”.
The Magellan Global fund now has a 5 per cent weighting to companies exposed to China, down from as much as 15 per cent at the end of 2020.

Since then, the tech crackdown has made steady progress and issued severe penalties for the major players – these are viewed as a sign that the regulatory crackdown on tech is coming to an end after three years.

Last month, Ant Group paid US$1 billion in penalties and Tencent was fined US$410 million for regulatory breaches while e-commerce giant Alibaba already paid an antitrust fine of US$2.8 billion in September 2021.

This closure was reiterated in a statement by the People’s Bank of China that the “focus of the financial regulators has shifted from collectively rectifying the fintech businesses of tech platforms to business-as-usual supervision”.

Roman Cassini, head of ESG at Hosking Partners, said: “In recent years, we underestimated the impact of government regulations and the rising competitive intensity within the industry, but there are early signs that these headwinds are abating. 

“At the same time, management teams are placing greater emphasis on higher quality growth and cost efficiencies, which in most cases has led to improved profitability.”

Lai added: “A lot of the technology risk has reduced and there are leading businesses which should be able to grow their market share. Valuations have come down a lot over the last two years and are very cheap.
“The authorities have got over the idea of a heavy-handed crackdown and are now trying to get growth back.”

While its focus on mega-cap technology companies may be lessening, the government has now found a new target in artificial intelligence companies. 

It recently released a regulatory policy for AI companies which includes governing recommendation algorithms as well as rules for synthetically generated images and chatbots. It will also reframe the building and development of AI solutions within China.

In a fund update, Jacqueline Liu, portfolio manager on the T. Rowe Price, China Growth Opportunities Equity Strategy, said this should be viewed in a positive light. She feels the government is seeking to get in on the front foot rather than acting retrospectively at a later date which could cause disruption.

“We view the government as learning from the past. Historically, Beijing often let new industries grow in size for a number of years before bringing in government regulations. This risked creating negative investor sentiment as the businesses involved were already big and the impact of new regulation was uncertain,” said Liu.

“This time, Beijing has stepped in early to guide the industry and to provide regulatory direction. This should help companies to adjust their products and business models at an early stage in order to comply with the new regulations.”

Cassini concluded: “We would hesitate to question the country’s long-term potential. Even if the unprecedented growth rates of the early 2000s and 2010s are behind us, China will likely remain a pivotal player in global economics and politics for the duration of the 21st century and beyond.”