How Investors can Respond to China's Five Year Plan

China recently offered glimpses into its economic blueprint over the next five years, which laid out a vision for becoming a global leader in technological innovation, establishing self reliance in the manufacturing of semiconductor chips that lie at the core of all tech ambitions. It also pledged to build a robust domestic market - achieved by elevating the income of the average Chinese consumer. 

While it seems that the strategy of China here is to pivot inwards domestically – which deviates slightly from China’s traditional pursuit for global expansion – it must be noted that this is not new. What has changed is only the sense of urgency - battling a fallout with major trade partners due to the pandemic, as well as dodging political brickbats from global superpowers must have surely taken its toll. 

 Here are 5 things we know so far about the 14th Five Year Plan:


1. No target for GDP Growth yet

China has steadfastly held on to a 6% growth target for the last decade and met targets with heavy government spending on infrastructure. Although no GDP target has been set yet for the next five years, expectation for a figure closer to 5% is likely more realistic given the backdrop of slowing global growth. 

China will continue to pivot from a manufacturing economy to a consumption driven economy. Consumption contributes less than 40% to GDP growth, behind the 70% of a developed country like the US. There is room for the Chinese consumer to grow – the plan is to turn China into a “high income” nation by 2025 and a “moderately developed” nation by 2035. This essentially means pushing up China’s per capita income of USD$10,410 as of 2019, to $12,535 by 2025, and $20,000 by 2035, going by standards set by the World Bank. To double the income of China’s 1.4 billion people by 2035 will mean that Chinese tech consumer stocks will stand to gain the most. 

I have covered these stocks in my article here. Since then, what has changed is the stricter regulatory landscape where the most high profile casualty, Ant Financial, which is 30% owned by Alibaba, saw its IPO on 5 Nov abruptly postponed because its micro financing business arm was deemed to not have met banking standards.

Regulatory oversight to stop anti-competitive practices in the internet sector were also announced on 7 Nov, causing stock prices of e-commerce companies like Alibaba, JD.com, Tencent and Meituan Dianping to take a hit. Pinduoduo, on the other hand, despite being China’s 3rd largest e-commerce platform, escaped the sell off likely because its business model is based on group buy discounts.

Regulations are a necessary evil for stability and trust and will pay off in the long run. Any market sell off therefore presents a buying opportunity for investors.



2. Speed up its “dual circulation” growth model

The term “dual circulation” was coined in May and refers to China’s two-pronged approach to driving growth via domestic demand as well attracting foreign investment. China continues to open up its financial markets. Foreign investors hunting for yield can look at 10-year Chinese Government bonds which still offer yields in excess of 3%. With a track record of zero defaults and an A+ rating, Chinese government bonds also have a low co-relation with global bond peers and with equities, making it a good portfolio diversifier.

Chinese government bonds are also slowly being recognized in global bond indices: the Bloomberg Barclays Global Aggregate Index (BBGA) since April 2019, some of JP Morgan’s various bond indices including the widely followed Global Diversified Bond Index (GBI-EM) since February 2020, and soon the FTSE World Government Bond Index (WGBI) in Oct 2021. The inclusion into the WGBI will likely bring additional bond flows of USD$150B according to UBS estimates.

Investors can gain exposure to Chinese government bonds via the ICBC CSOP FTSE Chinese Government Bond Index ETF (CYC:xses) listed on the Singapore stock exchange. The ETF has 82 bond holdings with a YTM of 3.05% and a fairly short duration of 5.65 years. As the primary currency of the ETF is in SGD and USD, investors face currency risk as the bonds are denominated in yuan. Returns on the ETF will be eroded if the yuan weakens.

The yuan is trading at its strongest level against the US dollar since May 2019 and has appreciated 8% in the last 6 months to trade at the current 6.55 handle. Yuan strength should remain supported for three reasons: 

• China’s fast economic recovery relative to global peers – strong exports fueled by high demand for Chinese goods like masks and covid related items, a lower import bill due to lower commodity prices and a slump in outbound tourism, will give rise to a large current account surplus relative to its GDP and will lead to yuan appreciation over time.
  
  
• The pivot inwards to building a strong domestic market means the Chinese government will support a strong yuan to increase buying power of the locals. 
  
  
• Opening up of financial markets means a stable yuan is necessary to boost investor confidence. 

Right now, the medium-term outlook remains extremely constructive for the Chinese yuan and should put investors at ease when investing into RMB denominated assets. 


3. Build tech self-sufficiency

The tech war with the US has only turbocharged China’s resolve to develop proprietary technology and achieve self-sufficiency. President Xi Jinping has pledged an estimated USD$1.4 trillion through 2025 for the research and development of key technologies. Broad goals for the semiconductor sector include producing 70% of domestic needs within China by 2025 and reaching parity with globally benchmarked cutting-edge technology by 2030.

Developing its chips technology underpins all of China’s technological ambitions. Having to rely on external sources for more than 84% of chips supply has made China vulnerable to demands of trade partners, such as with the case of Huawei Technologies which suffered a crippling disruption to its manufacturing of mobile phones after the US imposed sanctions on any company supplying chips made with US technology to Huawei.

China currently does not have leading-edge semiconductor manufacturing facility – SMIC (981:xhkg)  only began production for creating chips from the 14 nanometer (nm) technology node in late 2019, putting it about a decade, or at least two generations behind leading edge foundries run by TSMC, Samsung in South Korea, and Intel in the US. 

China can play catch up by leveraging on attracting foreign talent and expertise with above-market salaries, joint ventures, even intellectual property theft, or vertical integration. With global survival at stake and billions to burn, it will be erroneous to assume what seems impossible will remain impossible.

Investors can gain direct exposure to semiconductor manufacturing stocks like SMIC (981:xhkg) and Hua Hong (1347:xhkg), or look at the Global X China Semiconductor ETF (03191:xhkg).


4. Tackling climate change – carbon neutral by 2060

In a surprise announcement at the United Nations General Assembly in Sept 2020, President Xi Jinping pledged that China will aim to reach peak carbon dioxide emissions by 2030 and carbon neutrality by 2060. This is the first time such concrete targets have been set since China ratified the Paris Agreement in 2016. The shift to clean energy could require anywhere from 5 trillion to 15 trillion in investment, much of it in wind and solar power generation. Investors should watch these green energy stocks:

Electric Vehicle-related manufacturers:
• NIO (nio:xnys)
• BYD (01211: xhkg)
• Xpeng (xpev:xnys)
• Geely (0175:xhkg)
• Global X China Electric Vehicle ETF (02845:xhkg)

Lithium battery manufacturers:
• Ganfeng Lithium (1772:xhkg) 
• Global X Lithium & Battery ETF (LIT:xarcx)

Renewable Energy companies:
• China Longyuan Power (0916:xhkg) the biggest publicly traded wind-farm operator in China,
• GCL-Poly Energy Holdings (00451:xhkg) – world’s largest producer of polysilicon, a key material for solar panels.
• Xinyi Solar holdings (00968:xhkg) – produces specialized glass to cover solar panels
• Flat Glass (6865:xhkg) - Photovoltaic glass (PV) Glass manufacturer
• Global X China Clean Energy ETF (02809:xhkg)

Green vehicles will make up 20% of new car sales by 2025 and 50% by 2035. While EV stocks have skyrocketed in tandem with the "Tesla effect" in the US, earnings need to play catch up for prices to be justified. Investors who have missed the rally can look to lithium and renewable energy companies with better fundamentals that will drive the upside.


5. Peace with Hong Kong, Taiwan and Macau

The ongoing 2019-2020 Hong Kong protests, also known as Anti-Extradition Law Amendment Bill movement, remain a political crisis with no end game in sight. China implemented the “National Security Law” in July 2020 and that has curbed civil unrest to a large extent. Financial and economic stability is at stake, and though China reiterated its desire for long term stability in the region and will seek peaceful reunification with Taiwan, it remains to be seen how well China can navigate this storm.


Trading Inspiration:

Consumer tech stocks:

• CSOP Hang Seng Tech Index ETF (03033:xhkg)
• iShares Hang Seng Tech ETF (03067.xhkg)
• iShares MSCI China ETF (MCHI:xnas)
• Schroder ISF Greater China Fund (SISGRCA.MFU)

Others:

• ICBC CSOP FTSE Chinese Government Bond Index ETF (CYC:xses)
• Global X China Semiconductor ETF (03191:xhkg)
• Global X China Electric Vehicle ETF (02845:xhkg)
• Global X Lithium & Battery ETF (LIT:xarcx)
• Global X China Clean Energy ETF (02809:xhkg)