Data as of October 25, 2022. Source: Bloomberg.
Amplifying the economic uncertainty is China’s chronic pain of the financial turmoil stemming from Evergrande, the country’s second-largest property developer. The gravitational pull of its ongoing debt problem continues to drag other parts of the economy into its orbit. With housing accounting for approximately one-third of China’s GDP, precarious fundamentals in that sector have had a ripple effect. Companies along the production chain, such as steel and construction services firms, are taking losses from Evergrande’s inability to pay. ZCP could exacerbate the problem if it undermines consumer confidence, generates higher levels of unemployment, and inhibits the ability of Chinese citizens to purchase homes. If real estate sales continue to plummet, it could worsen current economic woes and elevate domestic volatility in equities.
Security over growth
In his speech, Xi Jinping mentioned the word “security” 91 times and spoke of China cultivating “indigenous innovation” as part of the broader goal of national self-reliance—especially in technology. Beijing’s newest targeted industrial policy is unprecedented and involves heavy investment in frontier tech. This is in large part being fueled by Beijing’s rivalry with the U.S., particularly in the areas of strategic technologies. These include artificial intelligence (AI) and semiconductor chips used to power AI with various military and non-military applications.
On October 7, President Joe Biden issued sweeping restrictions on China’s access to semiconductors and the equipment to manufacture them. Vis-a-vis each other, the U.S. and China are now prioritizing security over mutually beneficial economic agreements; particularly in the areas of strategic technology, a cornerstone of Xi’s agenda to cement China as a global superpower.
In addition to manufacturing strategic technology at home, Xi has also been stressing the importance of domestic self-reliance. From a policy perspective, this involves shifting from an export to a consumer-driven economy. This accomplishes two goals. One, it reduces dependence on the West, and two, it helps insulate China from financial and economic convulsions from the U.S. and Europe. Reading between the lines, what this means for Xi is that he is able to pursue regional political ambitions and reduces the cost of Western response (e.g., sanctions—as in the case of Russia invading Ukraine).
Reunification with Taiwan
A key part of Xi’s political ambitions is the reunification of Taiwan with the mainland, an outcome he sees as inevitable. The prospect of a direct war between China and the U.S. weighs heavily on policymakers, though it is unclear when it will happen—if even at all. Chinese officials have already met with banks to understand how their overseas assets could be protected in the case of U.S. sanctions. With Xi at the center of policymaking and the PSC resolutely behind him, a military operation in Taiwan would likely be a Xi-driven strategy—and a violent one. The economic and financial disruption from such a conflict would be enormous and could exacerbate supply-chain bottlenecks and amplify shortages in key products like semiconductors.
Lastly, Xi’s speech placed a strong emphasis on “Xi Jinping Thought” as the ideological foundation of the CCP, and therefore, the country. Complementing his Marxist-based theory is the idea Xi put forth of “common prosperity” and alluded to notions of wealth distribution. From the perspective of entrepreneurs and investors, this is antithetical to the mode of capitalist governance that made China an attractive investment vehicle. With wealth distribution being a centralized, top-down process, it may create more regulatory scrutiny for domestic businesses and foreign investors. Businesses may therefore be hesitant to expand their commercial enterprises, and foreign investors may reduce their investments in China out of concern of sudden policy moves. This is not unlike what happened in Hong Kong, shortly after the passage of the National Security Law. Beijing’s crackdown on the tech sector for ideological reasons is a tangible example of this, and China’s markets are feeling it. The Wall Street Journal (quoting the Rhodium-Atlantic council) found that “foreign direct investment as a share of China’s GDP has declined steadily, to 21% last year from nearly 30% a decade earlier.” If centralization of power and ideology continue to walk hand-in-hand, the economy and domestic markets may pay the price for it.
Xi’s speech and the conviction behind his principles and policies illustrate the many challenges investors face in what appears to be a new age of centralized governance. The prioritization of political policies over economic integration is part of the larger trend of deglobalization. In this environment, emerging markets may exhibit more policy-related volatility than has been the case historically.
This does not mean U.S.-based investors should reject emerging markets equities or, more specifically, Chinese equities. Valuations for Chinese equities are very compelling, and our allocation to emerging markets equities typically incorporate active managers with “boots on the ground” and long track records of investing in China. Additionally, a very strong dollar has weighed on emerging markets equities in 2022. As we approach the Federal Reserve’s peak fed funds rate for the cycle, we expect the U.S. dollar to lose some steam. That would provide relief for emerging markets economies with significant debt denominated in U.S. dollars. Historically, a weakening dollar has been correlated with better relative returns of emerging markets equities versus those of the U.S.
China-related risk adds to an already long list of macro concerns. However, the Investment Committee sees considerable risk as already being priced into markets and thinks the time to reduce risk has passed. Our portfolios hold an overall neutral allocation to equities but with a preference for U.S. large caps over international equities versus the long-term strategic asset allocation benchmark. Our portfolios also hold a neutral allocation to fixed income, an overweight to cash, and underweights to real assets and alternatives. We continue to monitor the economy and markets and will adjust portfolios accordingly.
Thematic Research Strategist
CSI 300 Index is a capitalization-weighted stock market index designed to replicate the performance of the top 300 stocks traded on the Shanghai Stock Exchange and the Shenzhen Stock Exchange. It has two sub-indexes: the CSI 100 Index and the CSI 200 Index.
Facts and views presented in this report have not been reviewed by, and may not reflect information known to, professionals in other business areas of Wilmington Trust or M&T Bank who may provide or seek to provide financial services to entities referred to in this report. M&T Bank and Wilmington Trust have established information barriers between their various business groups. As a result, M&T Bank and Wilmington Trust do not disclose certain client relationships with, or compensation received from, such entities in their reports.
The information on Wilmington Wire has been obtained from sources believed to be reliable, but its accuracy and completeness are not guaranteed. The opinions, estimates, and projections constitute the judgment of Wilmington Trust and are subject to change without notice. This commentary is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or a recommendation or determination that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on the investor’s objectives, financial situation, and particular needs. Diversification does not ensure a profit or guarantee against a loss. There is no assurance that any investment strategy will succeed.
Past performance cannot guarantee future results. Investing involves risk and you may incur a profit or a loss.
Indexes are not available for direct investment.
Reference to the company names mentioned in this blog is merely for explaining the market view and should not be construed as investment advice or investment recommendations of those companies. Third party trademarks and brands are the property of their respective owners.
Wilmington Trust is a registered service mark used in connection with various fiduciary and non-fiduciary services offered by certain subsidiaries of M&T Bank Corporation including, but not limited to, Manufacturers & Traders Trust Company (M&T Bank), Wilmington Trust Company (WTC) operating in Delaware only, Wilmington Trust, N.A. (WTNA), Wilmington Trust Investment Advisors, Inc. (WTIA), Wilmington Funds Management Corporation (WFMC), and Wilmington Trust Investment Management, LLC (WTIM). Such services include trustee, custodial, agency, investment management, and other services. International corporate and institutional services are offered through M&T Bank Corporation’s international subsidiaries. Loans, credit cards, retail and business deposits, and other business and personal banking services and products are offered by M&T Bank. Member FDIC.
©2022 M&T Bank and its affiliates and subsidiaries. All rights reserved.
 Tony Sachs, From Rebel to Ruler, July 6, 2021.
 Xi’s Power Grab Spurs Historic Market Rout as Foreigners Flee, Bloomberg.
 Key Takeaways From Xi Jinping’s Two-Hour Speech.
 Bloomberg data.
 Bloomberg data.
 Shanghai lockdown: Economy shaken by zero-Covid measures, BBC News.
 China’s property market debt could weigh on the country for years, economist George Magnus warns.
 China Evergrande’s Debt-Crisis Fallout: Losses, Layoffs and More Defaults.
 Xi Jinping provokes a spectacular sell-off in China’s markets.
 China Working to Protect Overseas Assets in Amid Fear of US Sanctions, businessinsider.com.
 Xi Jinping’s Ideological Ambition Challenges China’s Economic Prospects, The Wall Street Journal.