Though onshore and offshore China markets sank on trade uncertainty in May again, we saw two silver linings this year. First, domestic monetary condition improved meaningfully on the back of a series of easing measures to inject liquidity since 4Q18. Second, we expect market sentiment to be less bearish than last year. For much of 2018, markets were still worried about whether the government would implement any stimulus, and even if they do, the efficacy of the stimulus. And in 2019, the first quarter’s high frequency data largely beat market expectation, giving market participants confidence in China’s ability and determination to stabilize growth.

Why Economic Data Softened in May?

Even so, we need to understand thoroughly as to why the economy seems to have weakened again in April and May. Naturally, the re-surfaced trade tension was one of the reasons behind the softening. However, we think that the Government is indeed very conscientious of not turning this supportive stance into a massive stimulus program.  A very clear signal has been sent through its management of the systematic liquidity, as evidenced by the movement of the 7-days Repo rates (RP07) of the inter-bank market (see chart¹).

Source: Bloomberg, as of May 2019

Since mid-2018, the Government has been loosening its monetary stance, hence RP07 has been trending down from around 3% to a tad below 2% in 1Q19¹. On the back of the apparent stabilized performance of the economy, the Government clearly did not want to incrementally provide the economy with excessive liquidity, and the Repo rate rebounded moderately since mid-March. We endorse such a prudent policy approach as we concur that targeted easing and focus on effectiveness of the measures (such as tax cuts and more productive infrastructure investments) are far better means to safeguard the economy than a “shot-gun approach”.

We take the view that the measures announced/implemented so far should be good enough to arrest the downside of the economy, should the trade tension not be re-ignited. We are very convinced that the impact from the renewed trade tension in recent week is, similar to the situation in the US, more on sentiment and business confidence in capex and longer-term planning. Since the US seems to have secured a “Fed put” on a weak economy due to the trade war, we think that a loosened US monetary stance is very likely to provide more room for the People’s Bank of China to effect an equally accommodating policy since the pressure on China capital account should ease.

More Counter-cyclical Measures In The Toolkit

If the 25% tariff on USD 200bn remains in place for a few months, the estimated direct impact on China’s growth via trade and supply chain is estimated at around 0.5% of GDP². We think China has more counter-cyclical measures, e.g. accelerated and better-targeted credit growth and augmented fiscal deficit, to offset the impact of tariffs. The latest policy of relaxing the use of proceeds from Specialized Local Government Bonds for initial equity investments in Fixed Asset Investment projects is in-line with this board policy approach, which would de-bottle-neck some of the structural barriers in the credit creation process. If trade escalation persists in the future, China still has some room for further reserve requirement ratio cuts and will likely roll out pro-consumption measures.

[1] Source: Bloomberg, as of May 2019

[2] Source: Morgan Stanley, as of May 2019

Disclaimer

This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.

Investments involve risks. Past performance is not indicative of future performance. You may lose part or all of your investment. You should not make an investment decision solely based on this information. Each Fund may have different underlying investments and be exposed to a number of different risk, prior to investing, please read the offering documents of the respective funds for details, including risk factors. If you have any queries, please contact your financial advisor and seek professional advice. This material is issued by Zeal Asset Management Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong.

While Sino-US trade conflict continues to affect global markets and business confidence, multinational companies have been adjusting their business strategies. According to a survey by Bain & Company, 50% of American corporates went into a wait-and-see mode last year amid uncertainties, but 60% are ready to take action this year¹. Should China be worried that manufacturing production will move away?

Low end manufacturing has been moving from Pearl River Delta and Yangtze River Delta regions to lower-cost Southeast Asia for quite a number of years, as Chinese workers’ wages keep rising and the government is determined to reduce pollution. In order to transform China into an advanced global manufacturing economy, the country has been changing its manufacturing strategy and devised a ten year plan to move up the value chain. Admittedly, China carries some fundamental weaknesses in core technology independence, such as semiconductors; however, China’s strength lies in its manufacturing capability. With traditional low cost value proposition and its focus and development of innovation to develop advanced technologies in manufacturing, China was ranked as the most competitive manufacturing nation in 2016². Many of world’s most popular electronics are assembled in China, with high-tech exports increasing from 24,639 million USD in 1998 to 504,380 million USD in 2017³. Germany and Japan also excel in producing quality hi-tech products; however, their shrinking and aging workforce and high cost make it more difficult to deliver customized products with mass production efficiency.

Infrastructure is critical to building a strong manufacturing supply chain. We need fundamental facilities and systems to serve an industrial cluster, such as roads, bridges, ports, water supply, sewers, electrical grids, and telecommunications. An efficient and complete supply chain which can produce quality products in massive supply requires not only solid infrastructure, but raw material supply, such as labor and industry cluster. Can Southeast Asia, India or Mexico easily copy a supply chain ecosystem in the near future? To answer this question, we can think about the following four factors.

Capital

China has been investing billions of dollars in building the supply chain infrastructure during the forty years of reform and opening up so that it has successfully nurtured thousands of industrial clusters, varying from textile manufacturing to high-end industrial robot production. Infrastructure systems require large-scale construction, which involves capital-intensive financing.  It’s possible to build and operate scattered factories in developing countries for multinational companies, but raising capital to finance nationwide infrastructure projects that can facilitate versatile supply chains  is a big challenge.

Talent

Talent and labor force is the most important driver of a country’s manufacturing ability to compete on the global stage. First, an economy needs a stable supply of construction workers to build infrastructure efficiently, but most countries are facing manpower shortage as very few young people would consider a career in the construction industry. Second, high end manufacturing requires skilled workers to fill critical positions, such as machine/equipment operators and automation supervisors, and this talent pool may take years of education and training to develop. Most developing countries face challenges in addressing the skills gap and attracting talents to relocate to their local plants.

Pollution

Besides the Great Wall, the first thing foreign travelers hear about Beijing might be the air pollution. Expats even coined the term “Beijing Cough” to describe a bout of persistent dry cough or throat tickle caused by poor air quality. China’s rapid manufacturing expansion comes at the expense of the environment and the government has been very determined about fighting pollution in recent years, even being willing to tolerate slower economic growth. Many Southeast Asian countries’ economic growths rely heavily on tourism and some ecosystems are already under threat of over-exploitation. Nowadays, how many countries are willing to sacrifice the environment to pursue fast industrial development?

Time

Last but not least, building a sustainable supply chain takes a long time. China took decades to build infrastructure, train skilled workers, and nurture industrial clusters. Even if there were enough capital and talents, countries still need many years to develop their manufacturing capability without devastating the environment.

On May 20, the US footwear industry, including the Top 2 Sports brands in the world – Nike and Adidas, sent an open letter to the White House and urged the Trump Administration to consider a halt in raising tariffs on footwear imported from China, saying that a 25% tariff “will add $7 billion in additional costs for our customers, every single year.”⁴ Facing trade protectionism in different regions, shoe companies have been working on addressing trade issues and preparing to reduce the impact in recent years. Many have been shifting part of production out of China to save cost and reduce reliance on a single country. For fiscal year 2018, China manufactured approximately 26% of total NIKE brand footwear and 26% of total NIKE Brand apparel, compared with 47% and 18% from Vietnam, respectively⁵. Puma sourced 24% of its products from China, while Vietnam contributed 32%⁴. But still, China represents an important sourcing country and consumer market for global footwear and apparel industry. As said in the letter, companies cannot simply move factories to adjust to these changes since they need to make sourcing decisions years in advance.

When moving factories out of China, multinationals need to take a lot of factors into consideration, such as the costs of relocation, labor market (not only cost, but also size and skills of labor force), physical infrastructure, supplier network, legal and tax system, political stability, supporting industries, etc. Certainly, a country’s manufacturing competitiveness level may vary from industry to industry, but China still has competitive advantages in high-end mass production.

[1] Source: CNBC, as of April 2019

[2] Source: Deloitte, as of March 2016; Deloitte Touche Tohmatsu Limited and US Council on Competitiveness, 2016 Global Manufacturing Competitiveness Index

[3] Source: Knoema, as of Dec 2017

[4] Source: Bloomberg, as of May 2019

[5] Source: NIKE Annual Report, as of May 2018

Disclaimer

This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.

Investments involve risks. Past performance is not indicative of future performance. You may lose part or all of your investment. You should not make an investment decision solely based on this information. Each Fund may have different underlying investments and be exposed to a number of different risk, prior to investing, please read the offering documents of the respective funds for details, including risk factors. If you have any queries, please contact your financial advisor and seek professional advice. This material is issued by Zeal Asset Management Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong.

There can be no assurance that any estimates of future performance of any industry, security or security class discussed in this presentation can be achieved. The portfolio may or may not have current investments in the industry, security or security class discussed. Any reference or inference to a specific industry or company listed herein does not constitute a recommendation to buy, sell, or hold securities of such industry or company. Please be advised that any estimates of future performance of any industry, security or security class discussed are subject to change at any time and are current as of the date of this presentation only. Targets are objectives only and should not be construed as providing any assurance or guarantee as to the results that may be realized in the future from investments in any industry, asset or asset class described herein.