Red China blues

  By Guest Blogger Doug Rowat

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For those investors who assumed China was a perpetual growth machine, a rather remarkable thing happened earlier this month: China reported its first annual population decline in more than 60 years.

The 2021 to 2022 population drop was less than a million people, but the fact that the data showed a record-low birth rate indicated that the Chinese population is broadly ignoring the easing of the country’s one-child policy, which was lifted in 2015. Couples are reluctant to have children because of reduced wages and a slower economy, and couples are waiting until later in life to marry. China will very shortly lose its status as the world’s most populous country:

China’s concerning population trajectory

Source: United Nations. Data for China excludes Hong Kong, Macao and Taiwan.

Demographic challenges are nothing new. I’ve cited Japan’s lack of population growth before; however, a potentially more concerning problem for China is that, unlike developed countries, it lacks established wealth. The old maxim of a country that’s “getting old before getting rich” is becoming increasingly applicable to China.

Several things can support a country’s long-term economic, and hence, equity-market growth. In particular: 1) ample natural resources, 2) innovation, 3) a young, productive workforce and, as noted above, 4) already established wealth. China is questionable on point 2) as its main strength is manufacturing, it’s running out of 3), which will ultimately affect manufacturing, and it has far less of 4) relative to developed nations:

Mean wealth per adult (US$), select countries

Source: Credit Suisse, Turner Investments

China’s real estate problems are also well documented. Last year, residential property sales declined 28% fueled by investor skepticism over developer defaults as well as soaring property prices. The Financial Times reports that “six wallet” has now become the home-affordability catchphrase in China. In other words, couples have to tap their own two wallets as well as those of all four of their parents to purchase a home. And an opinion piece in the South China Morning Post last year offered this blunt assessment of China’s property market:

China’s property bubble is deflating quickly. The vast industry and local governments are trying to revive it. But it won’t work. The sector is beset by developers’ financing woes and massive supply overhang amid high household debt, a property affordability crisis and, crucially, a collapse in the rate of marriage.

Registered marriages in China have been falling since 2013. The Chinese are no different than us. Were you more likely to own a home before or after marriage? You bet: after.

Equity markets have definitely taken note of all of the above. Chinese equities have underwhelmed in recent years. For example, the CSI 300 Index, roughly the Chinese equivalent of the S&P 500, has gone nowhere in the past five years (in fact, it’s declined slightly). Compare this to the S&P/TSX Composite, which is up more than 30%, or to the S&P 500, which is up almost 50%. Interestingly, even when China does record impressive economic growth as it did in 2021, the post-pandemic bounce-back year, investors are often responding with a shrug. China’s GDP grew 8.1% in 2021, but Chinese equities dropped 2%. India, as a point of comparison, grew its 2021 GDP at a similar rate (8.9%), but its equity market rose 31%.

No one is challenging the impressiveness of China’s past growth. It was exceptional. Credit Suisse, for instance, notes that China’s wealth creation between 2000 and 2021 was so impressive that it “enable[d] it to leapfrog 80 years of US history from 1925 onward within a span of 21 years.” And we know, of course, that China routinely recorded double-digit annual GDP growth throughout the early and mid-2000s. At least officially.

But such growth rates are a thing of the past. The World Bank estimates that China’s growth last year reached only 2.7%—a figure that barely kept pace with the growth rate of many developed countries (Canada, for instance, will likely record 3.8% GDP growth in 2022, according to StatCan’s early estimates).

I haven’t even touched on other issues surrounding China including the geopolitical risks associated with Taiwan or the social unrest created through its Covid response. China may be taking a more relaxed stance with its Covid lockdowns now, but it remains to be seen how long this will last, or conversely, what economic costs this new approach will extract as its health care system is strained. According to Forbes, the US has almost 35 ICU beds per 100,000 people. China only 3.6.

No globally balanced portfolio can ignore exposure to the world’s second largest economy and this may indeed be a good year for Chinese equities—they’re off to a great start and The World Bank is forecasting an economic rebound this year, estimating a more China-like 4.3% growth rate (though notably, The World Bank highlights many risks to this forecast).

However, a portfolio heavily overweighted to Chinese equities, fueled by the promise of limitless growth lasting for generations, is no longer prudent.

China’s best days are likely in the rearview.

Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Investment Advisor, Private Client Group, Raymond James Ltd.