China’s economy remains on the right track

In spite of what recent headlines and market volatility imply, China’s economy has been stabilizing over the past year, and its services industries continue to grow fast.

Furthermore, Beijing’s recent decision to start weaning itself out of its old, restrictive exchange rate regime is a welcome step that will support domestic growth. Thus, despite various challenges, China remains on track to achieve its strategic goals. It also remains a must-have market for long-term investors.

Concerns about China have repeatedly weighed on markets in recent years, and resurfaced again after its short-lived equity bubble burst last summer. Today, many investors are also concerned the possibility of a big, one-time devaluation of the yuan, and some are speculating that such a step could come at or after the G20 finance ministers’ meeting that starts in Shanghai this Friday.

We believe such fears are overdone. Yes, China faces significant challenges. Its economy will slow even further in coming years, and its banks will need years to fully digest the multi-year credit binge they unleased after 2008.

Finally, the yuan should also continue to gradually depreciate, at least as long as China needs to keep the domestic supply of its currency ample. The latter is required to support growth and avoid accidents during this difficult economic transition. Policy glitches and temporary setbacks will occasionally occur in future as well.

However, what really counts is that all of the above is occurring in the context of a necessary and positive transformation of a huge, increasingly sophisticated economy, which is continuously shedding many of its most inefficient, heavily polluting, and least valuea dding industries.

Furthermore, this process offers opportunities that will ultimately pay off for investors that follow a prudent and selective long-term approach, without getting distracted by China’s constant macro noise, and its near-term policy dilemmas.

The time has come to become more constructive on China
At the same time, even China’s short-term outlook is not as bad as many headlines and market action currently imply. A broad set of fairly reliable economic indicators shows that China’s economy has actually been – modestly but consistently – improving over the past year.

In recent years, the LGT Beacon has often expressed skepticism whenever various China bulls or media headlines appeared to proclaim that China was about to rebound on the back of some sort of economic stimulus or political development. But, as things stand today, it is time to become more constructive on China.

In contrast to any other time since 2013, the broader data trend is now indeed pointing to an economic stabilization. But even if this were to prove just another false down, and Chinese growth were to slow further in the near future (which is inevitable over the longer-term anyway), the fact remains that China’s services industries continue to expand at a brisk pace.

Ultimately, that is the part of China’s economy that is interesting for investors. It is also the part we focus on as a firm, for example in our private equity business – the long-term investment approach par excellence.

New currency regime is a step in the right direction
Lastly, and perhaps most importantly, China is unlikely to abruptly devalue its currency. As described above, the country’s main economic headwinds are of a domestic nature. A strong one-time devaluation would cause unnecessary disturbances, and only temporarily prolong the life of industries that China does not need in order to achieve its strategic goals.

In the meantime, the recent decision to let the yuan track a trade- and capital flow-weighted index of other currencies, rather than the US dollar alone, represents another important step in the right direction. The new currency regime allows China to gradually break free from the US monetary policy cycle, and to pursue policies that are more adequately tailored to its own needs. Its adoption is therefore by definition a fundamentally growth-friendly step for China.

Mikio Kumada, global strategist LGT Capital Partners

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