Does China Matter for YOUR Retirement Portfolio going into 2023?
Post-China President Xi Jinping’s latest meetings with U.S. President Joe Biden, Chinese equities and those stocks exposed to the Chinese economy have rallied strongly off depressed levels over the last month. Maybe it’s been the notion of China relaxing its Zero-Covid policy? Or maybe it’s been China’s relaxing monetary policies to help cushion their ongoing credit crunch on real estate property developers? I don’t know, but it’s likely to have been a combination of the two after an almost three-year crackdown on economic growth and re-focusing of China inwardly as Xi campaigned for and won his unprecedented third term as party head.
I’m Chris Perras, Chief Investment Officer at Oak Harvest Financial Group, and I want to address why China matters to almost every stock and bond investor nowadays, whether you directly invest in Chinese equities, own multinational corporations, or just index your portfolio to the S&P500. Before I do, make sure you click on the subscribe button as well as the notification bell, so our team can notify you when we upload new content.
As China’s Zero Covid rules enter its third year, there are new signs of discontent across the country. For China’s leader, the social unrest is a test of his third term and underscores the question of how he can lead China out of the Covid era. The recent displays of defiance are rare for the Chinese and are the most visible signs of frustration with the lockdowns, quarantines, and mass testing that have upended everyday life. Even minor “re-opening” efforts in China have led to rapid increases in Covid cases due to prior policies. It’s safe to say, that one man and one policy cannot control a virus.
China’s struggles are of Mr. Xi’s own making. He has stuck with his “zero-Covid” policies aimed at eradicating Covid infections, even as its vaccination efforts have lagged. For three years, Xi pumped out propaganda in support of tough controls, arguing they were the only way to protect lives. They eschewed outside help in vaccine development. They chose “not invented here” and “command and control” over ingenuity and flexibility.
So why does this matter still? For global investors, getting China’s economic direction right, matters. Why? China has the world’s second-largest economy measured by nominal GDP, totaling around US$17.7 trillion in 2021. Take a look at the table summarizing the last 20 years of China’s growth. Whether the numbers are correct or not, they are truly amazing.
How did China accomplish this? On the back of becoming the manufacturer to the world for consumers globally. China is now the world’s largest manufacturing economy and exporter of goods. Moreover, up until Covid hit in 2020, it was the world’s fastest-growing consumer market and second-largest importer of goods. It is also the world’s largest consumer of industrial commodities and accounts for about half of the global consumption of metals. It is the largest trading nation in the world. At the same time, China has been, until recently, the largest recipient of foreign direct investment. It received capital investment inflows of $163 billion in 2020. Whether you agree with their politics, Covid methods, or civil rights, economically, China has grown so big now versus the 80s or 90s. China matters once again.
Since the early 2000s, in front of the 2008 Beijing Summer Olympics, China has been the single largest growth engine for the world economy. In front of the Olympics, it was all about domestic investment. Building factories and a housing boom fueled massive growth in the rest of the world. Take a look at the chart from Alpine Macro showing Chinese exports as a percentage of GDP over the last two decades. While their increased openness and growth push from 2000 through 2010 fueled a huge uptick in commodity inflation, China’s output and cheap labor allowed the rest of the world to experience very low inflationary pressures. Many western countries outsourced basic manufacturing to China during this period. This trend continued almost unabated through 2019. However, it has run into a brick wall since Covid reared its head in early 2020. Since then, the notion of supply chain diversification, not supply chain optimization, has been thrust into the forefront of manufacturers, suppliers, and consumers outside of China.
The fact is that the manufacturing sector in China is larger than the U.S. and Europe combined. China trades more than the U.S., with over 70% of all countries worldwide. In 2000? This ratio was the other direction, with the USA trading more with 90% of the countries in the world and China only 10%. China’s manufacturing concentration makes it nearly impossible for the U.S. to isolate China within the global economic ecosystem, as much as politicians in Washington DC might try. However, without a vibrant or stable global economy, given China’s concentration in manufacturing, China cannot continue its growth and attempt to pull 10s of millions further out of poverty and into its economy on its own. China, like its trading partners, is caught in a catch-22.
Domestically, the loosening of zero-covid restrictions is proving on again off again and creating short-term chaos in domestic consumption and manufacturing. One only needs to read the daily stories surrounding Apple and its main manufacturing partner Foxconn to understand the disruption that the No Covid policies are having.
In early November, Apple announced that it expected lower high-end iPhone 14 shipments due to supply chain disruptions taking place in Zhengzhou. This manufacturing center is known as “iPhone city” and employs over 200,000 who are responsible for most iPhones produced in the world. It’s not just on the manufacturing side that China’s Covid policies can hurt investors by changing costs or revenues or both.
Apple currently accounts for 18% of the Chinese smartphone market. This makes China nearly a quarter of Apple’s global sales, according to a Shanghai-based smartphone analyst. International companies like Apple that sell into the Chinese markets have a delicate balancing act. With its 1.3 billion citizens, China is where a big part of the growth global markets has experienced over the last 20 years. This will likely be even more so over the next 20 years as China transitions from an export economy to one more focused on domestic consumption. With the quest for future growth, Apple, and other multinational companies, have many reasons not to rock the boat or risk ending up on the wrong side of China’s government.
In addition to the country’s zero Covid policies disrupting supply chains globally and consumer demand locally, there are several other issues that your investments may face in China. Number one on the list? Tensions between Beijing and Washington over Taiwan, the self-governed democratic island China has claimed as part of its territory, have ballooned this year. The escalation started when Speaker of the House; Nancy Pelosi visited the island on what looks like her farewell tour. Taiwan is the global capital for semiconductor chip manufacturing used in most electronic devices. Taiwan’s market share in high-end chip manufacturing is almost 85%. It is also the headquarters for several key Apple suppliers, including Foxconn, Pegatron, and Wistron. Take a look at the market share chart on semiconductor manufacturing. As you can see, it’s very lopsided and concentrated in Taiwan.
Just two months ago, The Biden administration rolled out extensive new restrictions on China’s access to advanced semiconductors and the equipment used to make them. The restrictions require a license for the sale of advanced semiconductors to entities within China. This will, of course, lower semi-demand short term and likely increase consumer costs. However, the policy’s goal is to try to deprive China of the computing power it needs to train artificial intelligence that they might use for military purposes or surveillance. Currently, TSMC and its South Korean rival Samsung are the only foundries capable of manufacturing the most advanced 5-nanometer chips, and TSMC is already gearing up for the next-generation 3-nanometer chips.
The new rules also extend restrictions to chipmaking equipment like AMAT, ASMLF, and LAM Research. These restrictions amount to the single most substantial move by the U.S. government to date in its quest to undermine Chinese technology capabilities. The big picture is that Chinese foundries have been cut off from acquiring cutting-edge equipment it needs from ASM Lithography, a Dutch company, and other equipment manufacturers. ASML makes the extreme ultraviolet lithography equipment that’s used to produce the most advanced chips, such as those manufactured by TSMC and Samsung.
While these restrictions may be in the U.S.’s best interest from a national security perspective, this will clearly disrupt end chip demand and increase costs of consumer electronics as almost every part of the semiconductor supply chain has significant American components. China will not only not have direct access to U.S.-fabricated chips, but China’s chip design companies won’t have access to fabs that use American equipment. Moreover, Chinese fabs will not have access to U.S. equipment, and Chinese equipment companies will not have access to U.S. components and service and maintenance. At the end of the day, keep an eye on what’s going on in China, as it will likely be a significant force in what types of stocks outperform and when they outperform the markets in 2023. In short, China remains a big deal for the markets and, likely, much of your investment portfolio, whether you are directly invested there or not.
With the volatility the markets have experienced in 2022, our investment team recommends that you get on the phone and give our Oak Harvest team a call and ask to speak to one of our financial advisors and planners. Set up a meeting, sit down with one of our team, and let us walk you through how the sequence of returns can affect your retirement plan every bit or more than the average investment return your current advisor is generating.
Give us a call at (877) 896-0040 and give our investment team a chance to help you with your investment allocation and have our financial planning team model your cash needs and greed into and through your retirement years. Whether your cash account is yielding a few basis points or a few percentage points, The entire Oak Harvest team is here to help you navigate into and through your retirement years.
I’m Chris Perras and from everyone here at Oak Harvest, have a blessed weekend.
CFA®, CLU®, ChFC®
Chief Investment Officer, Financial Advisor
Chris is a seasoned investment professional with over 25 years of experience working with some of the most successful money management firms in the world. Chris has made it a point in his career to adapt as the market landscape changes, seeking to utilize the appropriate investment strategy for a given market environment. His transition from managing billions of dollars at the institutional level to helping individuals and families retire is guided by a desire to see first-hand the impact he is making in the lives of clients at Oak Harvest.