Emerging Markets: How to play China’s move to a current-account surplus

China’s shift to a large current-account surplus has significant implications for investors. Pendal’s Global Emerging Markets Opportunities team explains the challenges and opportunities

• China’s move to current account surplus largest global shift since COVID
• E-commerce and online companies provide opportunities
• Find out more about Pendal’s Global Emerging Markets Opportunities Fund

HERE in Pendal’s emerging markets team we place high analytical importance on the structural current account balances that different countries run.

The decision to follow a domestic demand-led, current account deficit model versus an export-led, surplus model has significant implications for the economy and equity market of a country.

A country’s current account is a key part of its balance of payments. It measures the flow of goods, services, income and transfers between a country and the rest of the world.

A sustained current account surplus shows an economy that consumes less than it produces.

The causes of such a surplus are complicated and much-discussed.

But it can be thought of as a combination of precautionary saving by the people (often where welfare provision is thin) and by the country (theoretically to have sufficient foreign exchange reserves to manage economic volatility).

For equity investors, this tends to mean opportunities in domestically oriented companies will be fewer, with weaker growth in domestic demand, less gearing of consumption to GDP (as GDP growth is led by exporters), and lower valuations for consumer companies.

Case studies include Korea, Taiwan – and interestingly Thailand and Malaysia which both moved from structural current account deficits to surpluses in the 2000s.

China moves to surplus

Added to that list now is China.

One of the biggest shifts in the world economy since the pandemic has been China’s move to enormous and enduring surpluses.

Just this week China’s trade surplus topped $US1 trillion for the first time as its manufacturers shipped more to non-US markets to avoid President Donald Trump’s tariffs.

China’s total surplus in manufactured goods, according to customs data, now exceeds US$2 trillion, which is around 10.5 per cent of GDP.

The surplus in all goods is US$1.2 trillion – around 6 per cent of China’s GDP – having increased by about US$800 billion since 2020.

A lot of attention has been paid to the trade and geopolitical implications of this change –although still less than should be, partly because China reports an improbably low current account surplus of only 2.2 per cent of GDP.

What it means for emerging markets investors

This also has significant implications for those investing in China.

A US$2 trillion surplus in manufactured goods is US$1400 per capita, which can be thought of as the Chinese people’s under-consumption relative to what they produce.

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That, in the light of the ultra-competitive nature of many Chinese industries, makes for a very difficult environment for many of China’s consumer companies.

Where companies have defensive business models – for example, through technology, network effects or brand – China offers great opportunities.

We remain very positive on some of the e-commerce and online companies held in the Pendal Emerging Markets Opportunities Fund portfolio.

For other Chinese companies though, the lack of fiscal stimulus means the economic downturn is expected to continue.

And a policy preference for export-led growth and large external surpluses is likely to cause that downturn to be felt hardest in Chinese domestic demand.

Since the global environment is now very positive for many other emerging markets – and with strong opportunities in Chinese financials and e-commerce winners – we have substantially reduced our portfolio exposure to Chinese consumer stocks.

Our investment process is highly selective, both at the country level and within our preferred countries, and our focus on liquidity allows us to sell holdings where the top-down is no longer supportive.

About Pendal Global Emerging Markets Opportunities Fund

James Syme, Paul Wimborne and Ada Chan are co-managers of Pendal’s Global Emerging Markets Opportunities Fund.

The fund aims to add value through a combination of country allocation and individual stock selection.

The country allocation process is based on analysis of a country’s economic growth, monetary policy, market liquidity, currency, governance/politics and equity market valuation.

The stock selection process focuses on buying quality growth stocks at attractive valuations.

Find out more about Pendal Global Emerging Markets Opportunities Fund here
 
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