While the prospect of inflation and the debate over whether it is just passing through or permanent will dominate markets in coming months, I think Australia should be more concerned with the impact of the economic slowdown in China. Everyone seems so focused on the reopening of the Australian economy they are not looking at the other headwinds emerging.
China has dramatically changed course in the past 12-18 months. They are battening down the hatches from both an economic and political perspective. Their ‘Common Prosperity’ mantra is the overriding political philosophy ushering in a new period of consolidating the government’s power and control.
Unlike the West, China thinks long term. They will forgo higher growth now if consolidating makes their nation stronger and better prepared for the battles ahead. I believe this consolidation is in line with their longer-term ambitions around Taiwan and the South China Sea.
There are many examples where the Chinese government has deliberately destroyed businesses and industries and actively limited their potential profit. Combine this with the government crackdown on property debt and developers, the world now faces the prospects of a China with materially lower growth prospects.
The level of sovereign risk in the communist nation makes investment there untenable. In the past 12 months, they have torpedoed their own internet giants Tencent, Baidu and Alibaba to the point that their share prices halved. They banned all education and tutoring companies from making a profit. In September, they banned children from playing video games for more than 3 hours a week.
The philosophical differences between China and the west make investing there a nightmare. The Chinese government is not concerned about that though. This is about consolidation of power first and the economy second. But it is certainly consolidation of both.
The property and construction debt problem in China appears to be an issue that China will manage over time. While there will be serious fall out, it may not be the economic disaster that was initially feared. It is likely China still grows and we will continue to see the emergence of the middle class.
But in the short to medium term, exposure to China growth is best found via the Chinese consumer. That doesn’t really help Australia as we are highly leveraged to the building of China. But with around 65% of the Chinese population now living in cities we are starting to move to the next stage.
Ironically, a phase of manageable consolidation for the Chinese government is likely the worst outcome for Australia.
When China is building and booming, demand for our resources is high and obviously Australia does well. If China does poorly, for example a major economic disaster, then we are likely to see China launch a massive stimulus package and focus on new infrastructure. Again, great news for Australia and the iron ore price.
But if China goes through a period of consolidation, Australia has a problem. In a consolidation phase, we’re going to see sustained lower iron ore prices and lower volumes. It will impact our entire economy, starting with the mining sector and flowing through to property and the banks. I think it is likely the Australian economy is going to struggle in 2022 as it finds itself hit harder by the Chinese slowdown than almost any other country.
From an investment perspective, I think there are still great opportunities in some sectors here in Australia, but I have reduced our client’s exposure to Australian shares. I am avoiding direct stocks in Chinese companies as the sovereign risk is simply too high. Most importantly, I prefer international equities over Australian shares at the moment. I am slowly increasing our portfolio holdings in blue chip international stocks, especially in the US.
This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you.