On the face of it life in China is returning to some sense of normality. Since April all travel bans have been lifted for the country including the city at the epicenter of the original outbreak, Wuhan; restrictions on dining out have been relaxed and there was a surge in customers visiting restaurants. In the May golden week public holiday, the most popular travel time of the year for the nation, 115 million Chinese were on the move, according to the Ministry of Culture and Tourism.¹ Few ventured far, however, with most people visiting destinations within their home provinces. Travel further afield risked tourists being placed into quarantine on their return home, based on a colour- coded system from an app downloaded on to mobile phones.² While factories are operational again, many are suffering from a decline in orders due to a global demand shortage; a prominent example is Foxconn, Apple’s largest supplier in the region, which reportedly asked some of its workers in Shenzhen to take extended leave from May to September.³ In effect, this ‘new normal’ means businesses navigating new challenges amid weak global demand and restricted consumption.

The pandemic is exacerbating old challenges too. Nowhere is this more apparent than in China’s increasingly fraught relationship with the U.S. whilst an underlying tension has been present for years, the fallout from COVID-19 has once again made a reappraisal of relationships a pressing necessity. After years of ideological misgivings between the world’s two largest trading partners, policy-makers and Chinese corporates need to adjust swiftly as trade and geopolitical relationships falter.

Arguably the biggest challenge of all is China’s own growth model. Investment-driven domestic growth does not have the same allure as it did after the last crisis in 2008: China’s share of the global economy has tripled from 6% pre-global financial crisis (GFC) to 18% in 2017 while aggregate global demand is weaker.⁴ The domestic debt burden is also much higher, with an estimated debt-to-GDP ratio of 298% at the end of 2020 compared to 154% pre-GFC, and with credit now only half as effective as before at driving growth. Chinese policy-makers need to work out a new investment framework to continue yielding productivity gains but without the same level of debt expansion.

Nevertheless, observing first-hand the changes being undertaken by Chinese companies and policy-makers gives us cause for optimism. In a scenario where some level of global ‘decoupling’ becomes inevitable, the country’s domestic demand growing at 11% should provide a buffer.⁶ On the trade front, even amongst the worst-hit export sectors, there are companies and industries that are well positioned to weather the storm. The service industry is being galvanized by the technology sector and is more vibrant and important than ever, retaining an attractive runway for the economy’s future growth.

This paper will attempt to identify the four key trends that we expect will help to address these structural challenges that China faces.

First, companies are actively moving capacity abroad to reduce costs and stay close to the end consumer. Second, those that are able to move up the value chain are better placed to weather the storm, however some are still vulnerable. Meanwhile, growth can still be generated domestically from the most mundane traditional industries, such as logistics and real estate. Finally, the Chinese government is ready and willing to redirect its investment into targeted areas for the next phase of growth, as it did a decade ago. We will then look at how these changes impact investing in China. Whilst economic growth will be lower in future, from low double digit growth rates early in the past decade to mid-to-single digit in the next few years, the outlook for Chinese equity returns need not follow a similar path.⁷ In fact, structural market changes could see returns increase in certain sectors, even as the overall growth slows, but the benefits will be unevenly distributed, making a selective investment approach particularly important.