Investment Adventures in Emerging Markets


China 2021 Outlook: Pandemic Fuels Momentum for De-Globalization, What’s Next?

The coronavirus has sharpened the divide between China and the rest of the world and accelerated the trend toward de-globalization already in place, according to Franklin Templeton Emerging Markets Equity’s Chetan Sehgal and Michael Lai. They share their outlook for China, how the health care story could continue to unfold there, and the potential opportunities for investors they see in the year ahead.

This post is also available in: French, Spanish

China’s COVID-19 Containment Measures Sharpen Global Divide

Michael Lai: As we all know, 2020 was a bit of a gamechanger as the world was confronted with a public health crisis. China’s early response to the coronavirus outbreak through contact tracing and alterations in general societal behavior helped China come out of the pandemic in better shape relative to the rest of the world.

There was a lack of global leadership on fighting COVID-19, but China marched ahead with containing the virus. As a result of its early response, China is now closing the economic gap with its competitors, including the United States.

Chetan Sehgal: I think China has handled the pandemic response well, particularly given the country’s vast size and population. Chinese authorities were quick to act, implementing unprecedented measures through city lockdowns and quarantines to contain the virus. China’s response doesn’t seem to have been replicated to the same degree in other countries due to societal norms and cultural differences—mask-wearing and adherence to government-mandated rules have been met with some resistance in societies that tend to be more democratic. So, we have seen the pandemic sharpen the divide between China and the rest of the world in many aspects. Over the longer term, COVID-19 should be a bump in the road for China’s long-term growth, given it has been rebounding quickly from it.

Michael Lai: Mistrust has been building between China and the West for a number of years, even before COVID-19. Over the last four years, I think the penny has finally dropped amongst some in the West that China could pose a threat to political hegemony not just in Asia, but for the rest of the world.

Has Globalization Run Its Course?

Michael Lai: I think it’s clear that China is not going to be a template for liberal democracy. However, the policy regime that has focused on raising people’s living standards has a tremendously successful track record over the last three decades. Gross domestic product (GDP) per capita in China has soared from US$317 in 1990 to just over US$10,000 for 2019.1

The challenge now is whether China can overcome the middle-income trap, where the economy stagnates at middle-income levels. This has become a huge bane for emerging markets alike, with the exception of Singapore, Taiwan and South Korea.

For investors that can reconcile the differences between the West and China, there are still a lot of interesting opportunities from a bottom-up perspective. China is ultimately a domestic, consumption-driven economy. It has progressed from being the “factory to the world” to producing high-value technological goods such as computer chips, and fixed-asset investments and exports have become leading economic drivers in recent years.

Chetan Sehgal: COVID-19 has highlighted the fragility of global supply chains, which have come under mounting pressure to diversify away from a perceived excess dependence on China. That said, exports are in surprisingly good health because the supply chain in China remains intact and therefore the rest of the world has no choice but to rely on Chinese exports. Most countries are still trading with China—supply chains won’t change overnight, even if countries want to make a transition due to COVID-19 or other reasons.

As interests diverge, I think COVID-19 should accelerate the development of a dual supply chain to serve both markets. The uncertainty ahead places a greater premium on company attributes such as intellectual property, competitive positioning and adaptability. I think leading technology companies that possess these characteristics will continue to thrive.

Michael Lai: The reality is, the last 25 years of globalization seems to have run its course. Production will likely be split between China and the rest of the world. You can’t move a semiconductor production plant that costs US$10 billion overnight, so it will take time for some shifts to fully occur. Unfortunately, I think consumers will likely have to bear the brunt of costs of multiple supply chains as a result of geopolitical issues.

China’s Evolving Health Care Story

Chetan Sehgal: The health care sector is an area we’re watching closely at the moment. We’ve seen the Chinese government cultivate an environment where health care innovation is rewarded, so we’ve seen a lot of product approvals over the past year. The Chinese Food and Drug Administration (FDA) has also improved its standards for clearance, along with the unprecedented move of integrating innovative findings from China into global drug trials.

As a result, we’ve seen more competition within the market and a deflation of a lot of generic pricing. This will likely improve the prospect of affordable health care in China. However, something to bear in mind is that this could also potentially restrict the profit earning potential for companies in this space.

Michael Lai: What’s surprised me is the speed at which innovative procedures or products have received approvals this year, whether this is from the Chinese or US Food and Drug Administration (FDA). As investors, we’re particularly interested in Chinese companies that have US FDA approval, as it suggests the product is on the right path to receive Chinese FDA approval shortly.

It makes sense that generic drugs are already being squeezed on price, so the low-cost manufacturing denominator helps maintain an encouraging environment for innovation at the same time global health care costs are rising. Outside of COVID-19, there’s a lot of collaboration between the West and China in product innovation commercialization, irrespective of the target market. I think the value of commercialization will likely have a more important role in the future.

Opportunities Overlooked

Michael Lai: China has a limited set of moves right now in regard to the ongoing US-China trade disputes. That said, the latest Biden win could potentially ease tensions and likely lower the temperature. Most intellectual property is in the United States or other Western countries, so localization is the aim right now. However, China’s strategy has always been about long-term planning. Following its “Made in China 2025” global manufacturing plan, it will also implement an ambitious 15-year “China Standards 2035” plan to set the global standards for the next generation of technology. This will include a push for improved domestic standards in information technology and biotechnology, along with improving fifth-generation (5G) availability, artificial intelligence and big data—all of which are seen as crucial tools in future technology infrastructure.

Chetan Sehgal: I think it’s also very important to mention that investors can be exposed to the Chinese economy and market in more ways than just buying into listed assets in China. For example, you might buy a company in Brazil where the majority of its sales are dependent on the strength of the Chinese economy. That said, I still see immense opportunities for China going forward. COVID-19 has accelerated wider technology adoption, innovation and industry consolidation as companies across a broad range of sectors adapted to pandemic-induced trends.

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What Are the Risks?

All investments involve risks, including possible loss of principal. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in emerging markets involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size and lesser liquidity. To the extent a strategy focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a strategy that invests in a wider variety of countries, regions, industries, sectors or investments. To the extent a strategy focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a strategy that invests in a wider variety of countries, regions, industries, sectors or investments. China may be subject to considerable degrees of economic, political and social instability. Investments in securities of Chinese issuers involve risks that are specific to China, including certain legal, regulatory, political and economic risks.

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1. Source: World Bank.

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