Why Canadian investors should care about China’s slowdown

Click to play video: '‘We will not allow China to isolate Taiwan,’ Nancy Pelosi speaks for 1st time since Asia trip'
‘We will not allow China to isolate Taiwan,’ Nancy Pelosi speaks for 1st time since Asia trip
U.S. House Speaker Nancy Pelosi held a press conference on Wednesday for the first time since her visit to the self-ruled island last week, addressing the rising tensions between China and Taiwan. – Aug 10, 2022

As Canada’s central bank tries to cool the economy with another likely interest rate hike in September, authorities in China face a very different problem: slowing growth.

China’s economic issues may seem a world away for inflation-weary Canadians, but it pays for investors here to keep an eye on the other side of the Pacific, said Cyrus Kanga, an instructor at Camosun College’s School of Business in Victoria, B.C., and a former equities trader at Hong Kong-based brokerage CLSA.

“The (Chinese) economy has been such a global driver for the last decade or two,” he said. “Now that that’s shifting, that should be something that investors here are paying attention to, even if they don’t own Chinese stocks.”

Analysts and institutional investors say that a slowdown in China – the world’s second-largest economy and Canada’s second-largest trading partner – would have global knock-on effects. Even investors focusing on Canadian stocks or mutual funds may find that they are exposed to unexpected risks.

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“Given China’s importance from a trade standpoint, one has to take into account exposures to the various countries that they do trade with and the effects they will have on those countries,” said Sandy McPherson, the chief investment officer of the City of Edmonton, which has investments in Chinese companies.

McPherson says he views Canadian exports to China as an important gauge of the health of the Chinese economy. China’s record trade surplus last month with its global partners indicated not just a rise in exports from China, but that an anemic domestic economy has suppressed demand for imports.

Lockdown pressure

After years of strict measures to control the spread of COVID-19, Chinese consumers are more reluctant to spend, factory output is growing more slowly and new investment from companies not owned by the state is drying up.

COVID-19 controls ground China’s largest city, Shanghai, to a halt for two months earlier this year, and citizens across the world’s most populous country remain on edge as local authorities clamp down on even small outbreaks. Japanese brokerage Nomura calculated that nearly 80 million people in 22 Chinese cities accounting for 8.8 per cent of the country’s economic activity were under full or partial lockdowns as of Monday.

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Ikea shoppers in China panic, try to escape flash-COVID lockdown

On Monday, China’s statistics bureau said that, partly due to those COVID-19 controls, youth unemployment hit nearly 20 per cent in July, the highest rate since data became available in January 2018. The real-estate sector, which accounts for about a quarter of China’s entire economy, is suffering. Demand for new homes has slowed. Developers are struggling following years of debt-fuelled growth.

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In a sign of how bad things have become, a recent viral video showed a local official in a mountainous, rural area of the southern province of Hunan exhorting participants at a real estate exhibition to take the lead in supporting the market. “If you’ve bought one property, buy a second! If you’ve bought two, buy a third! If you’ve bought three, buy a fourth!”

At the same time, Beijing’s intervention against high-flying tech companies like Tencent and Alibaba has forced their stock prices down to earth, while unlisted TikTok owner ByteDance has been reported by Bloomberg to be trading at valuations at least 25 per cent lower than last year on private markets. Add to that an ongoing trade war with the United States, and the threat of real war over Beijing’s claims of control over the democratically ruled island of Taiwan.

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Josh Sheng, chief investment officer at Shanghai Tongshengtonghui Asset Management Co., said worsening relations between Beijing and Washington, D.C., are “first and foremost” among domestic investors’ worries, as the two sides continue to engage in a festering four-year-long trade war begun during the Trump administration.

A recent trip by U.S. House Speaker Nancy Pelosi to Taiwan, viewed by Beijing as a provocation to its claims of control, has further inflamed tensions between the global superpowers and rippled through markets in East Asia.

“The market is feeling uncertain about the potential actions that (U.S. President Joe) Biden and his administration will take on China, especially in cut-throat areas” like semiconductors, Sheng said.

China’s CSI 300 share index, which tracks stocks on China’s two biggest exchanges in Shanghai and the southern tech hub of Shenzhen, has reflected the gloom, losing more than seven per cent in July and falling about 15 per cent for the year to date. In contrast, Canada’s TSX index, which staged a sharp rally in July, is down about five per cent over the past eight months.

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Some Canadian investors in the Chinese markets may be feeling the pain. While five huge Chinese state-owned enterprises announced last week that they would delist from the New York Stock Exchange in a reflection of the rocky Sino-U.S. relationship and disagreements over auditing rules, other firms remain tradable in the U.S. through American Depositary Receipts (ADRs).

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But many more investors not specifically buying Chinese assets may still have significant exposure. As of March 2022, 10 per cent of the Canada Pension Plan’s net assets were denominated in Chinese yuan, about equal to its combined exposure to assets in euros and pound sterling, according to its most recent annual report.

Individual Canadian companies may also have closer links to China than many investors realize. Vancouver’s Teck Resources said in its 2021 annual report that it had derived more than $4.6 billion in revenues from China, more than a third of its total revenues for the year.

When investing in Canadian companies, “the average person isn’t thinking a lot about where the revenue’s coming from in terms of China specifically,” said Kanga. “You might be invested in China, you don’t even know it.”

Easing pressures?

Despite the rocky performance of Chinese markets this year, some see hope for a recovery. Zhang Yanbing, an analyst at Zheshang Securities, said the domestic Chinese market had stabilized in August, with shares reversing more than half of the previous month’s losses.

“As COVID controls become more precise and normalized, the impact and economic drag will weaken. In addition, with China’s strong monetary and fiscal policy, stable growth policies will remain in force, and there’s still plenty of policy room” to boost growth, he said.

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Illustrating that “policy room” and in contrast to efforts by the Bank of Canada and the U.S. Federal Reserve to cool economic activity, China’s central bank took the surprising move this week of cutting a key lending rate to try to rev up the economy.

Goldman Sachs, which says China is the only Asian market loosening its monetary policies, said on Wednesday that it expects a sharp rebound in China’s annual growth for the third quarter ending in September. Some investors say an easing of policy in China while other countries tighten could present attractive investment opportunities.

“Basically, from an investment standpoint you have to be there,” said McPherson, adding that Edmonton has a five per cent allocation to emerging markets, of which China is a “large part.”

Focusing only on Canadian markets means missing out on investment opportunities, while also raising exposure to country-specific risks, said Kanga, noting the strong home-market bias of Canadian investors.

“I think investors do need to get a little bit out of their comfort zones,” he said. “You should have a long-term view and you should be diversified. There’s a lot of opportunity, there’s so much growth happening overseas.”

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