China or USA? The structural issues set to dictate future capital flows

Ageing demographics, contrasting forms of governance and the race to become the next tech superpower are just some of the factors investors will have to consider in the decades to come.

Rather than exploring the investment case for Chinese or US equities in isolation, there is a need for investors to understand some of the structural forces that will shape the two economies in the years ahead to help decide where to invest capital.
 

That was one of the few areas of agreement between Rosanna Burcheri, portfolio manager at Fidelity International and Philip Saunders, co-head of multi-asset growth at Ninety One, in a debate I had the pleasure of moderating, held at Mercer’s Global Investment Forum (GIF) Europe in Barcelona last month.
 

Prior to the debate, I presented the Forum’s attendees with a question: if they were given 2% more capital for their equity allocation, would they use it to overweight US equities or China equities (A-shares) over a 5-year time horizon?
 

The results revealed a fairly even split, with 46% of attendees opting to overweight US equities, while 54% leaned towards China equities.
 

With speakers eager to pitch their arguments, and attentive listeners primed to revisit the question at the debate’s conclusion, Barcelona was set for a clash of the world’s largest markets.

Shifting demographics

The year 2030 will mark a demographic turning point for the United States, Saunders told the GIF – all baby boomers will be older than 65, expanding the size of the older population, with one in every five Americans projected to be at retirement age, according to the United States Census Bureau.
 

By 2060, nearly one in four Americans are projected to be 65 years and older, and while this represents an issue over the longer term, the US’s growing population means there will be more working-age people than ever over the coming decades.
 

And as Burcheri told Mercer’s GIF, working-age people are the “driver of growth in the economy” and the “pillar of productivity,” yet China’s workforce is set to drop by 35 million over the next five years alone.
 

China’s working-age population fell by 40 million in the 10 years to 2020 and now accounts for approximately 70% per cent of the population, according to the World Bank.
 

Yet the apparent success of Xi Jinping’s economic reforms can best be seen in the emergence of a new, digital middle class, Saunders retorted.
 

“The middle class in China will double over the next decade to about 600 million people, and that's significant,” he said. Combined with this a rural population of roughly 550 million becoming increasingly connected with the digital economy have “significant scope to move to cities,” Saunders said. Urbanisation, a key factor in China’s economic growth, is not dead.

Land of the free and fragile

Ronald Reagan once said: “The nine most terrifying words in the English language are: I’m from the Government and I’m here to help” – and that sentiment has been encapsulated by the US financial markets to some extent, aiding investors. Yet the guiding hand of government is shaping the US to provide investors with security and stability, Burcheri argued.
 

“The US is a very pro-business country,” she added, pointing toward three factors that attract investors: governance, property and freedom.
 

“The protection of physical property is what nurtures economic stability,” she said, with the affordance of security being used to “fuel innovation and to modernise the economy.”
 

She added that investors may be more comfortable putting their money in a country like the US where the rule of law is critically important.
 

Conversely, America’s politics are “fractured,” Saunders reasoned, reflecting “deeper problems in society”.
 

“We've got a dangerous situation whereby financialisation causes inequality, and it means it has to be sustained by very low real interest rates. That is not capitalism working particularly well in my book, and it's self-feeding.
 

“We have got something that doesn't look vulnerable, but actually, it's an increasingly fragile system,” he claimed.

The next tech superpower

While Saunders acknowledged the future dynamics of China’s economy are hard to predict accurately, owing to the close alignment with state policy, there is a case to be made for investments in China’s onshore equity market, namely in technology.
 

A clear signpost for this, Saunders argued, has been the Chinese government’s ambition to become the world’s leading technology economy, encompassing domestic research, design and manufacturing.
 

Additionally, China’s onshore market has a low correlation with other equity markets, providing a degree of diversification to investors, he added.
 

Saunders reasoned that the Chinese government is entering a “Sputnik period” of investment in technological research that will filter through to the private sector. Much like how US government-funded technology was critical to the design and production of the iPhone – to the benefit of Apple shareholders – the next wave of research and development in China may come to benefit tech start-ups located in Shenzhen rather than California.
 

This leads to a situation where US dominance in this area may be “set to erode as the rest of the world catches up,” Saunders stated, reshaping the global technology landscape.
 

On the face of it, American technology and communication businesses are outperforming their Chinese counterparts – at least in a very general sense. Yet the competition to become the next tech superpower is a global battle and Chinese businesses such as Huawei are leading the charge through the ‘Digital Silk Road’ – an initiative to meet the global demand for technology and connectivity.
 

Saunders pointed to Baidu, sometimes referred to as the “Google of China”, as it has 130 partners for its autonomous vehicle platform, including European carmakers, and is a clear symbol of Chinese technology’s encroachment into Western business.
 

Yet there will always be the argument of the American market’s ability to consistently deliver returns for investors, and as Burcheri explained, all under the protection of a government that seeks to promote private entrepreneurship.
 

While the next evolution of the technology market is hard to predict, Burcheri claimed it will be a very long time before the US market is categorically replaced as the world’s leading technology hub.

Where should your money go?

As Saunders said, China is increasingly becoming a legitimate investment opportunity, with a constructive long-term macroeconomic backdrop and an onshore equity market growing in reputation, priced at attractive relative and absolute valuations. Structural and social fragilities in the US may be underappreciated by some investors, but the US equity market has demonstrated its capability of delivering growth and value to investors, as Burcheri explained.
 

Compelling arguments, certainly, but it was the voice and views of attendees that mattered the most at this debate.
 

In the second round of polling GIF attendees remained quite evenly split between the two options. 47% of attendees would overweight US equities, while 53% would opt for Chinese stocks.
 

Despite a small swing towards the US, it is clear that a decision between US and Chinese equities is nuanced, and how this real-world decision may play out in the future remains to be seen.