What Does China’s ‘Common Prosperity’ Push Mean for Investors?
Significant change is under way in China.
In 2021, regulatory reforms to the economy saw policymakers shift their priorities from short-term asset performance to social well-being, or ‘Common Prosperity’. This was especially evident in areas deemed strategic to long-term policy goals, including a clampdown on internet platform companies, the ‘Three Red Lines’ policies for property developers, and rules on after-school tutoring.
The changes spooked investors, triggering a 37% peak-to-trough sell-off in Chinese stocks and a 7.5% correction in Chinese offshore USD bond markets.
As we move into 2022, those investor jitters are likely to persist as the economic landscape remains challenging and growth is poised to slow, in our view, to 5.0%. While this is to be expected as the government navigates emerging challenges, from a rapidly aging population and elevated debt levels to widening income inequality and a delicate geopolitical milieu, investors still have cause for optimism.
“Despite these speed humps, we believe investors with a long-term perspective can find pockets of opportunity in the Common Prosperity landscape, particularly in the high-tech manufacturing, green transition enablers, and China Internet sectors,” said Audrey Goh, Senior Cross-Asset Strategist at Standard Chartered Wealth.
Understanding ‘Common Prosperity’
This is not a new concept. In fact, it was named the “fundamental principle” of Chinese socialism at the 18th Party Congress in 2012 but is only now gaining prominence.
Broadly, it refers to more inclusive growth, featuring stronger social safety nets and a narrowing of the rich-poor, urban-rural divides that have driven income inequality in China to the fourth-highest level in the world. A pilot “Common Prosperity Zone” in Zhejiang offers a more concrete idea of what this might involve: the development of clean energy, high-tech manufacturing and digital industries, middle-class uplift, and economic self-sufficiency.
Common Prosperity policies will also drive China’s economic pivot away from manufacturing and property, and towards consumption. At the same time, they will support raising competitiveness via technology and innovation, improving growth sustainability and national security.
“As these historic shifts gradually unfold, the resulting uncertainty and complexity is likely to produce further financial market gyrations,” said Audrey Goh. “Investors will need to see beyond these short-term anxieties to focus on the long-term opportunities the Common Prosperity policies create.”
Green Energy
Beijing has set an ambitious target of reaching peak emissions by 2030 and carbon neutrality by 2060, and further boosted the green transition agenda via an agreement with the U.S. to collaborate on climate issues.
We expect the central government and state-owned enterprises to take the lead in green investment, catalysing private participation in the process. The transition is likely to bolster secular investment opportunities centred on renewables and less-polluting energy sources, as well as electric vehicles and their related supply-chain components. Recent estimates suggest that up to USD16 trillion of green infrastructure investment could be required for China to meet its 2060 target.
High-tech Manufacturing
Technology will play a fundamental role in shaping China’s ability to develop a self-sufficient and sustainable economy. China will therefore likely ramp up R&D investment via fiscal spending, as well as incentivising increased private sector R&D via subsidies and tax incentives.
Key areas include advanced technologies, specialised equipment and components, and essential materials along key supply chains. Within these areas, sectors that enhance China’s resilience – such as semiconductors, enterprise software, and certain industrial and manufacturing sectors (for example, commercial aircraft and high-speed rail) – are likely to be the focus of investment.
China Internet
Chinese Internet companies had a rough ride in 2021 but, despite suffering large capital outflows, the sector will play a critical future role in rebalancing the economy’s growth mix.
Internet firms well-placed to support growing domestic consumption present an attractive long-term opportunity when, as we expect, regulatory scrutiny moderates.
“Technical charts point to base-building at current levels, reducing the odds of further significant downside,” Audrey Goh said.
Economic rebalancing and more robust social safety nets could help reduce precautionary savings and boost discretionary spending among low- and middle-income groups. Shifting some household wealth away from property (which currently stands at 40%) to financial assets may also help address widening wealth disparity and free up land for more sustainable uses through changes in the tax code. This could incentivise a greater allocation of household wealth to be directed toward financial investments, deepening China’s capital markets.
As the private sector faces tougher regulations in some services areas, private capital may seek opportunities elsewhere, either in government-encouraged technology, renewable energy, or advanced manufacturing. Meanwhile, investment in public services will likely increase and move away from traditional infrastructure and construction.
“Given where valuations are, and policymakers’ focus on the Common Prosperity agenda, we see scope for potential upside earnings surprises across our themes in 2022.”
— Audrey Goh, Senior Cross-Asset Strategist at Standard Chartered Wealth
The Long View
Reforming a US$26 trillion economy will not be a rapid process, which is why investors seeking to capitalise on the ‘Common Prosperity’ transition will benefit from a long-term approach.
“Over a long-term horizon, we believe that a catch-up in the size of Chinese asset markets relative to the size of its economy could also be a tailwind to secular opportunities offered by the ‘Common Prosperity’ agenda,” Audrey Goh said.
The pace of financial-market liberalisation relative to the speed of economic growth has made China’s market size look like an international anomaly. While equity markets have gained a more prominent market share in global indices, China’s bond markets have remained relatively less accessible, and therefore smaller.
This may change now that Chinese government bonds are included in large fixed-income global benchmarks such as the FTSE Russell World government bond index. International flows, combined with incentives for domestic consumers to shift a larger share of their wealth into domestic financial markets, should help sustain faster growth in China’s asset markets.
Given the broad spectrum of this theme and the sub-industries making up the opportunity set, it is no easy task finding a pure-play benchmark to track what Common Prosperity entails for financial markets. Based on our analysis, the closest indices tracking our China thesis are the FactSet China Semiconductor Index, the MSCI China IMI Environment 10/40 Index and CSI Overseas China Internet Index.
“Currently, analysts are revising down their earnings growth estimates, but the pace of negative revisions is slowing, and investors with a long-term view may find themselves rewarded,” said Audrey Goh. “Given where valuations are, and policymakers’ focus on the Common Prosperity agenda, we see scope for potential upside earnings surprises across our themes in 2022.”
