How should Chinese equity investors deal with trade war risk? In this edition of our China on-site series, we show how we address this hotly debated issue and also highlight the strong momentum in the Chinese healthcare sector.
Even though trade tensions between the US and China have increased, a full-blown trade war is not our base-case scenario.
Over the past few months, US president Trump has made good on his campaign promises, having taken various measures to protect US industries. His actions, of which an increase in tariffs on aluminum is but one example, mainly appear to be targeting China, although lately Europe is more in the picture as well.
In our view, Trump is putting his bargaining chips on the table, while China is responding in a very measured way, aiming to de-escalate the situation and stressing the importance of free trade. Recently, the two countries reached consensus to reduce the US trade deficit with China by China importing more US products such as oilseeds, beef (figure 1), energy, automobiles, and aircraft.
The overall impact of the US measures on trade between the US and China as well as on China’s GDP is relatively small. Still, the Chinese authorities are keeping a close eye on developments, ready to mitigate any negative consequences. In April, for example, the People’s Bank of China announced a 1%-point cut in the Reserve Requirement Ratio for major banks, releasing RMB 1,300 billion in liquidity.
In our Chinese equity portfolios, we focus on domestic companies, which are little impacted by Trump’s protectionist measures. We select our stocks from within the following themes: ‘Technology & Innovation’, ‘Consumption Upgrade’, ‘Structural Reform’ and industrial innovation under the ‘Made in China 2025’ plan.
Although China is the world’s second largest healthcare market, its healthcare expenditure per capita is one of the lowest. This leaves a vast potential for growth, making it a very attractive area for investors.
Chinese healthcare is still in its infancy. As figure 2 shows, healthcare spending in China is among the lowest in the world.
1. Policy support: the government’s Healthy China 2030 plan aims to grow the sector to RMB 8 trillion revenue by 2020 (some USD 1.25 trillion), implying a 15% compounded annual growth rate (figure 3). The reform of China’s healthcare system is aimed at cutting drug prices, encouraging innovation and increasing healthcare capacity.
2. Demographic change: a growing middle class can afford healthcare, while at the same time the aging population pushes up demand.
3. Rise in chronic diseases, such as hypertension and diabetes, naturally increasing demand.
4. Broadening insurance coverage: as most Chinese now have some form of insurance, they are more likely to use healthcare services.
Over the past five years, the MSCI China Healthcare index has outperformed the MSCI China index by 27% per year. The leading players are gaining share, at a compounded annual growth rate (CAGR) of some 20%. Although valuations have risen somewhat, they are still reasonable.
Going forward, it’s not simply the tide raising all boats anymore. With some short-term headwinds, it’s key to be selective. Up until now, government spending on the healthcare sector has been huge, but this is likely to slow.
We like leading chemical and biological companies with innovation and R&D capabilities. On the other end of the spectrum, manufacturers of over-the-counter traditional Chinese medicine, such as nutrition supplements, are also attractive. The latter play into the Chinese’ increasing health awareness, are becoming more affordable and are deemed safer than chemical drugs by 73% of the Chinese population.