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October 10, 2016 | Global Equity
Something Old, Something New: Rebalancing in China

Portfolio Manager

Casey Preyss, CFA, partner, is a portfolio manager for William Blair’s Emerging Markets Growth, Emerging Markets Small Cap Growth, and China A-Shares Growth strategies. Since joining William Blair in 2000, he has been a research analyst covering industrials, IT, and resources stocks. Before taking on fundamental research responsibilities for William Blair’s global equity team, Casey was a quantitative analyst. Before joining the firm, he was an international equity research sales associate with Thomas White International. He received a B.S.B.A. from The Ohio State University and an M.B.A. from the University of Chicago’s Booth School of Business.

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As we noted in another blog post, emerging markets have experienced a long spell of gloom, but we believe their underperformance relative to developed markets has run its course, thanks to a variety of factors, including China’s ongoing rebalancing.

China continues to rebalance its economy from investment to consumption. Growth of gross domestic product (GDP) has continued to slow. It’s now at approximately 7%, and consumption accounts for close to three-quarters of incremental GDP growth. In other words, the country continues to transition away from heavy industry and fixed asset investment.

The transformation of Chinese society, with the emergence of a new middle class and subsequent changes in consumer patterns, interests us, as a significant demographic change is taking place.

A recent study showed that 60% of Chinese households now have an annual disposable income of $7,500, up from 20% 10 years ago. In addition, this more affluent middle class is connected to the internet and social media. The Chinese are well-informed, sophisticated consumers.

But the transition to consumption in China is much more than a transition to basic consumer goods; it’s also a transition to experiences and services, including education, travel, media, and publishing.

The chart below contrasts growth in “old” and “new” China. In old China, which includes power and utilities, banks, financials, industrials, and commodities, there is essentially little or no growth. New China, which includes healthcare, IT, publishing, movies, entertainment, travel/leisure, and renewable energy, is seeing very strong growth.

The next chart is a blueprint for where China wants to take its economy in the next decade. A key takeaway is what is not on the list: real estate, fixed asset investment, and financials. Rather, the government’s clear objective is moving up the technology value chain and improving the quality of life through healthcare, pollution control, and alternative energy. Reducing congestion via high-speed rail, and promoting robotics, food quality, and modern agriculture, are also key.

This is where the government is focused on taking the economy over the next 10 years, and where we are trying to position our investments in China. Interestingly, however, if you look at the broad Chinese equity indices, and the constituents of the standard Chinese exchange-traded funds (ETFs), you see old China—the utilities, the financials, the banks.

We continue to find exciting opportunities in the Chinese internet and advertising market. Ad spending, in particular, has grown significantly in China over the past two years to become the second-largest mobile ad market in the world after the United States. It’s now bigger than the ad markets of the United Kingdom, Germany, and Japan combined.

Moreover, as the next chart shows, the mobile advertising market continues to grow at triple-digit rates. This has profound implications from an investment point of view. The third- and fourth-largest digital media companies in the world are now Chinese. From our experience in China, the first-mover advantage, the network effect, and the technology barriers to entry mean that once those companies are in place, it’s very difficult to disrupt them.

Similarly, the Chinese tourism market has broad implications for the entire Asian region. The tourism market is growing at a 25% to 30% rate, and this is affecting everything from Japanese duty-free operators to Korean cosmetics companies to airport operators in Thailand, Australia, and New Zealand. Chinese tourists are creating investment opportunities throughout Asia. This clearly reflects the ongoing momentum in China’s transition to consumerism.

Implications

Against this evolving backdrop, we believe it will be important to look at sectors and individual companies from a fundamental perspective to effectively identify investment opportunities going forward.

Portfolio Manager

Casey Preyss, CFA, partner, is a portfolio manager for William Blair’s Emerging Markets Growth, Emerging Markets Small Cap Growth, and China A-Shares Growth strategies. Since joining William Blair in 2000, he has been a research analyst covering industrials, IT, and resources stocks. Before taking on fundamental research responsibilities for William Blair’s global equity team, Casey was a quantitative analyst. Before joining the firm, he was an international equity research sales associate with Thomas White International. He received a B.S.B.A. from The Ohio State University and an M.B.A. from the University of Chicago’s Booth School of Business.

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