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March 11, 2021  |  Global Equity
China’s Unwavering Growth Journey

Portfolio Manager, Global Research Analyst

Vivian Lin Thurston, CFA, partner, is a portfolio manager for William Blair’s China A-Shares Growth strategy and a global research analyst covering Chinese equities. Previously, she was a global research analyst covering large-cap consumer companies. Before joining William Blair, Vivian was vice president and consumer sector head at Calamos Investments. Before that, she was an executive director and senior investment analyst at UBS Global Asset Management/Brinson Partners, where she was responsible for stock selection and research for consumer sectors in the United States and emerging markets. Vivian also held roles at Mesirow Financial, China Agribusiness Development Trust and Investment Corporation, and Vanke. She is a member of the CFA Institute and the CFA Society Chicago. She is also the founder and chairman of the board of the Chinese Finance Association of America, a 501(c) nonprofit organization. Vivian received a B.A. in sociology from Peking University and an M.A. in sociology and M.S. in finance from the University of Illinois Urbana-Champaign.

Portfolio Manager

Clifford Lau is a hard- and local-currency portfolio manager on William Blair’s emerging markets debt (EMD) team. Before joining William Blair, Clifford was the head of fixed income, Asia-Pacific, and a senior portfolio manager at Columbia Threadneedle Investments, based in Singapore. In that role he was responsible for managing Asian fixed-income assets, developing new products, and promoting the company’s expertise across the region. Before that, Clifford was head of the Singapore office for Pramerica Fixed Income, the asset-management division of Prudential Financial Inc. In that role he managed approximately $1 billion of Asian fixed-income assets. Clifford holds an Investment Representative License with the Monetary Authority of Singapore and is a CFA Charterholder. He received a bachelor’s degree in finance from the University of Hong Kong.

China led the world into the COVID-19 pandemic and was the first country to emerge. As we look ahead to the remainder of 2021, what does the modern Middle Kingdom have in store? We asked Vivian Lin Thurston, CFA, partner, a portfolio manager on our China A-Shares Growth strategy, and Clifford Lau, CFA, a portfolio manager on our EM debt team.

China was the first country to go into the COVID-19 crisis, and was the first one coming out. How does its recovery look at this point?

Vivian: Chinese gross domestic product (GDP) has continued to recover strongly after contracting 6.8% year-over-year in real terms in the first quarter, the height of the pandemic for China. It is the only major economy in the world to post positive GDP growth in 2020 (2.3% in real terms). And that recovery should continue, with current consensus estimates putting 2021 real GDP growth at 8.2%.

“COVID-19 has created a stronger impetus for China to make the changes needed to address the past few years of U.S.-China trade frictions.”

— Clifford Lau, CFA

Are we seeing any changes as a result of COVID-19?

Clifford: I think COVID-19 has created a stronger impetus for China to make the changes needed to address the past few years of U.S.-China trade frictions. The idea of dual-circulation strategy was invented exactly to cultivate those changes, de-emphasizing globalization and focusing more on domestic and regional growth.

How big of a role has fiscal stimulus played in China’s recovery? Is it sustainable?

Clifford: Fiscal stimulus has certainly played an important role in China’s recovery, though not to the extent we have seen in other countries. Many of China’s export competitors have seen massive production disruptions, putting China, which emerged from lockdown much sooner, in a good position to fill the gap. That reduced pressure on the government to stimulate the economy via fiscal spending. The country’s fiscal deficit of 4% to 4.5% in 2020 is manageable and below the global norm.

Vivian: The stimulus, in my view, was very sensible because countries facing a disruption event like a pandemic need a jumpstart. The stimulus was also well structured (with around 30% coming from tax and fee reduction, which directly benefits consumers and enterprises, and addresses structural issues at the same time). In addition, that amount of stimulus won’t be necessary in 2021, once the economy gets back to normal growth.

Much of the fiscal support was focused on the corporate sector and infrastructure investments, leading manufacturing to outperform services. How do you see the transition from investment to consumption taking placing in 2021?

Vivian: Inherently, after pandemics, manufacturing tends to recover sooner and respond to stimulus faster than services given their different natures. It takes longer for consumers to feel safe and comfortable consuming again, while manufacturing resumes immediately.

But we have seen services catch up quickly in recent months, and even surpass manufacturing. Since May 2020, the average monthly Caixin China services PMI is up more than 7% year-over-year, ahead of manufacturing PMI, which is up around 4%. This indicates the recovery in services consumption is taking hold very nicely.

Clifford: The transition to consumption is already taking place as mobility increases and the servicing sector recovers more. The return of wage growth should also lend great help for domestic consumption in the coming year.

Vivian, what drove Chinese equity performance in 2020, and do you see the same factors continuing in 2021?

Vivian: There were two key drivers of Chinese equity performance in 2020: better-than-expected management of the COVID-19 pandemic, and swift and effective stimulus. Those drivers will likely decline in relevance in 2021. However, quality growth companies (which we seek out) tended to be the bigger beneficiaries of the recovery and stimulus, and outperformed the overall market 2020. We believe that has the potential to continue in 2021.

“The performance of Chinese government bonds in 2021 will likely be a balancing act. Healthy offshore demand will likely be tempered by strong growth and the potential for inflationary risk.”

— Clifford Lau, CFA

Clifford, what do you think will drive debt performance in 2021?

Clifford: The performance of Chinese government bonds in 2021 will likely be a balancing act. We should see continued offshore inflows as local bond markets gain more attention from overseas investors due to a high yield gap (versus other developed markets) on the valuation front and expected index inclusion on the technical front. But this healthy offshore demand will likely be tempered by expected strong Chinese growth and the potential for inflationary risk. This will likely cap rates.

Has your investment case for China equities and debt changed?

Clifford: Not on the government bond side. The Chinese government avoided large-scale monetary easing in 2020 to avoid the massive pent-up risk that inevitably occurs when unwinding becomes necessary.

The Chinese government bond market also does not look overvalued, as economic resilience to the pandemic and supply from special issuance of local government bonds have been nudging the bond market to trade softer in 2020, which should preempt the bond market from a big sell-off in 2021.

“The investment case for Chinese equities is enhanced, because the transition to a domestic-consumption-driven economy has accelerated post COVID-19.”

— Vivian Lin Thurston, CFA

Vivian: The investment case for Chinese equities hasn’t changed; instead, it is enhanced, because the transition to a domestic-consumption-driven economy has accelerated after COVID-19, which should further benefit the sectors in which we like to invest (including consumer, healthcare, and technology) and the companies we favor (leaders in those sectors).

We’re also finding more quality growth ideas in the cyclical industries with structural growth drivers, such as smart infrastructure and green-energy-related industries, in light of the stimulus and government’s increased support to technological advancement and self-independence.

Clifford, where are you finding opportunities?

Clifford: China’s government bond market may surprise on the upside given that valuations do not appear to be overstretched, supply risk could come down, and offshore demand remains strong. With inflationary risk remaining low and food prices likely to normalize further in 2021, there are opportunities in long duration in the cash bond market and curve flattening trades in the derivatives market.

Can the strength of the Chinese yuan renminbi (CNY) continue? Where is the line in the sand?

Clifford: Assuming the U.S.-China relationship normalizes in 2021, growth returns to a medium-term trajectory of 5% to 6%, and offshore investors remain enthusiastic about allocations to Chinese equities and bonds, the CNY could further strengthen.

However, a strong currency does not always represent the best interests of the government and the economy (regarding export competitiveness, for example). Plus, with the risk of current accounts retreating back to borderline surplus and onshore diversification flows building up, the CNY may not have all the ingredients it requires for another strong year of outperformance. I think the best case is a strong resistance level of 6.35 to 6.40.

What impact do you think the new U.S. administration will have on the China investment case?

Clifford: At this point my best guess is no further escalation of what is the historically worst relationship between the two countries. But it will take time for both sides to reset the agenda. We should not expect the United States to immediately become reconciliatory given the bipartisan support to the existing approaches on both economic and political fronts.

“The transition to a new U.S. administration should not alter the investment case for China because China continues to shift to a domestic-consumption-driven economy and reduce its reliance on global trade and foreign technologies.”

— Vivian Lin Thurston, CFA

Vivian: I agree with Clifford that the new U.S. administration does not fundamentally change the U.S. view of China as a strategic competitor. Conversely, the transition to a new U.S. administration should not alter the investment case for China, because China continues to shift to a domestic-consumption-driven economy and reduce its reliance on global trade and foreign technologies.

We should see more Chinese companies get better and bigger at a faster pace than before, exhibiting accelerated growth, improved returns, stronger management, and better ESG attributes.

From my perspective, this remains a key fundamental support for attractive investment opportunities in China. Perhaps on the margin, the new U.S. administration may lead to more structured and predictable policies toward China, which would benefit the investment case for China in the near term.

What’s your guess for how 2021 will play out in Chinese equities and debt?

Clifford: For China’s government bonds, my base-case guess would be a benign inflationary backdrop coupled with tailwind for the CNY supporting strong inflows from offshore investors, which would result in rates rallying.

Vivian: I expect earnings growth of Chinese companies—especially quality growth companies—to remain strong in 2021 if current consensus estimates for Chinese GDP growth take hold.

The biggest unknown is valuation, especially after two consecutive years of strong bull markets. My base-case prediction is that price-to-earnings (PE) ratios of the markets overall should remain steady at current levels in the mid-teens. With that, we could still see solid appreciation in equities.

Emerging Markets Series
Part 1: Emerging Markets Roar Into the 20s
Part 2: 2021: The Strongest Growth in a Generation?
Part 3: Bullish on Emerging Markets Equities
Part 4: Emerging Markets Debt Well Supported
Part 5: Emerging Markets: Localized Opportunities
Part 6: 6 Themes Driving Emerging Markets Debt
Part 7: China’s Unwavering Growth Journey

Vivian Lin Thurston, CFA, partner, is a portfolio manager and research analyst on William Blair’s Global Equity team. Clifford Lau, CFA, is a portfolio manager on William Blair’s Emerging Markets Debt Team.

Portfolio Manager, Global Research Analyst

Vivian Lin Thurston, CFA, partner, is a portfolio manager for William Blair’s China A-Shares Growth strategy and a global research analyst covering Chinese equities. Previously, she was a global research analyst covering large-cap consumer companies. Before joining William Blair, Vivian was vice president and consumer sector head at Calamos Investments. Before that, she was an executive director and senior investment analyst at UBS Global Asset Management/Brinson Partners, where she was responsible for stock selection and research for consumer sectors in the United States and emerging markets. Vivian also held roles at Mesirow Financial, China Agribusiness Development Trust and Investment Corporation, and Vanke. She is a member of the CFA Institute and the CFA Society Chicago. She is also the founder and chairman of the board of the Chinese Finance Association of America, a 501(c) nonprofit organization. Vivian received a B.A. in sociology from Peking University and an M.A. in sociology and M.S. in finance from the University of Illinois Urbana-Champaign.

Portfolio Manager

Clifford Lau is a hard- and local-currency portfolio manager on William Blair’s emerging markets debt (EMD) team. Before joining William Blair, Clifford was the head of fixed income, Asia-Pacific, and a senior portfolio manager at Columbia Threadneedle Investments, based in Singapore. In that role he was responsible for managing Asian fixed-income assets, developing new products, and promoting the company’s expertise across the region. Before that, Clifford was head of the Singapore office for Pramerica Fixed Income, the asset-management division of Prudential Financial Inc. In that role he managed approximately $1 billion of Asian fixed-income assets. Clifford holds an Investment Representative License with the Monetary Authority of Singapore and is a CFA Charterholder. He received a bachelor’s degree in finance from the University of Hong Kong.

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Glossary

INDICES
The Bloomberg Barclays U.S. Aggregate Bond Index is a broad-based benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market, including Treasuries, government-related and corporate securities, mortgage-backed securities (agency fixed-rate and hybrid ARM pass-throughs), asset-backed securities, and commercial mortgage backed securities.

The MSCI ACWI IMI Index is a free float-adjusted, market capitalization-weighted index that captures large, mid, and small cap representation across developed and emerging markets.

The MSCI ACWI ex-US IMI Index is a free float-adjusted, market capitalization-weighted index that captures large, mid, and small cap representation across developed and emerging markets, excluding the U.S. The Value and Growth Indices are a subset of the Index that adopt a framework for style segmentation in which value and growth securities are characterized using different attributes. Multiple factors are used to identify value and growth characteristics.

The MSCI ACWI Small Cap Index is a free float-adjusted, market capitalization-weighted index that captures small cap representation across developed and emerging markets.

The MSCI Emerging Markets Index is a free float-adjusted, market capitalization-weighted index that is designed to measure the equity market performance of emerging markets.

The MSCI World Index is a free float-adjusted, market capitalization-weighted index that is designed to measure the equity market performance of developed markets.

The Russell 2000 Index is a market capitalization-weighted index designed to represent the small cap segment of the U.S. equity universe.

Index performance is for illustrative purposes only. The indices are unmanaged, do not incur fees or expenses, and cannot be invested in directly.

TERMS
Alpha is a measure of an investment's return in excess of the market's return, after both have been adjusted for risk.

Beta is a measure of the volatility of an investment relative to the overall market, represented by a comparable benchmark.

Half-life is a statistical measure of the time required for the discrepancy between price and value to contract by half of its starting value. Fundamental value estimates are based on the Dynamic Allocation Strategies team's proprietary research.

P/E Ratio is a measure of valuation which compares share price to earnings per share, calculated using estimates for the next twelve months.

Standard deviation is a statistical measurement of variations from the average.

QUANTITATIVE MODELS – FACTOR DEFINITIONS
The William Blair Earnings Trend Model captures information about short- and medium-term changes in analyst estimates in an attempt to anticipate future estimate changes and stock performance. The score combines measurements of earnings revisions, momentum, and earnings surprise.

The William Blair Valuation Model combines varying metrics used to characterize the relationship between the stock’s trading price and its intrinsic value. By going beyond using only one or two measures, the model attempts to build a more holistic version of a stock’s worth vis-a-vis the market. The score combines measurements of earnings/cash flow based, asset-based, and model-based factors.