“Dual circulation” might not sound like the niftiest moniker for an equity strategy, but it’s a phrase that’s captured the attention of investors in China’s $9.4tn stock market.
After first raising eyebrows in a May document, the Chinese Communist Party’s Politburo last month emphasised that a “dual circulation” strategy will be critical to China’s long-term development.
The idea is to twin a build-up in domestic economic strength in face of intensifying external risks – while maintaining China’s deep engagement with the global supply chain.
“Policy makers likely envisage China’s growth model in the future will be much less like Japan and Korea, but more like the US,” said Yi Xiong, chief China economist at Deutsche Bank AG in Hong Kong. “Preferences of domestic consumers will become more important than international ones in shaping companies’ decisions.”
Some of the investor reactions to directives from Beijing have sparked crazes as China’smns of retail traders, who dominate day-to-day transactions in the onshore market, rushed toward the new theme.
In particular defence, consumer and satellite stocks have outperformed lately, including:
n AECC Aviation Power Co, up 108% since the end of June
n AVIC Shenyang Aircraft Co, up 103%
n China Avionics Systems Co, up 45%
n China Satellite Communications Co, up 26%
There are few details on the new approach. President Xi Jinping oversaw the July 30 Politburo meeting where the “dual circulation” strategy was emphasised. That was days after Xi said at a gathering with business leaders that “we must give full play to the advantages of the domestic super-large market” amid rising protectionism and the global economic downturn. The strategy is to effectively reduce reliance on the West – just as other nations seek to become less dependent on China for economic growth amid rising US-China tensions.
Think tanks are already kicking into gear. A 21st Century Economic Research Institute study on Aug. 11 said that Chinese cities relying on overseas trade ought to reorient toward the domestic economy.
“A concerted shift by Chinese cities away from exporting over the next five years would reshape global trade patterns and supply chains,” analysts at Trivium China, a Beijing-based consulting group co-founded by economist Andrew Polk, wrote in a note.
The Communist Party’s Central Committee will meet in October to outline China’s next five-year plan, which could build out specific policies to buttress domestic demand.
Among the policy steps that Citigroup Inc analysts are watching for: income-tax cuts and social security contributions to boost household incomes, improved medical coverage to reduce precautionary savings and experiments with land reform to “unlock” rural wealth.
Private consumption amounted to 39% of China’s gross domestic product in 2019, “low” by both emerging market and Group of 20 nation standards, Citigroup economists including Xiangrong Yu wrote in an Aug. 9 report. The ratio in the US is more than two-thirds.
“Top-down policies are not to be taken lightly – they mean business,” said Wu Xianfeng, a fund manager at Shenzhen Longteng Assets Management Co. “It’s rewarding to follow the party’s lead when investing in China.”
But “dual circulation” may be a preoccupation for investors for some time to come, given that the context of the leadership’s discussions have been the country’s long-term development.
Wu said he’s already shifting some of Shenzhen Longteng’s positioning.
“We have been cutting on firms that have higher overseas exposure, such as consumer electronics, and going heavy on those that mostly rely on state investment,” such as satellite stocks, Wu said.
That tactic draws on a key component of China’s likely plan, which is enhancing its already high-priority moves to build up domestic high-technology industries, along with defense.
Another favored approach is looking at the companies likely to supply Chinese buyers who previously flocked overseas to snap up luxury items. New duty-free policies in May from the regional government of Hainan, a tropical island off China’s southern coast helped strengthen that narrative.
Department-store operator Wangfujing Group Co has been one of the big winners on that score, surging 292% over the past three months. China Tourism Group Duty Free Corp has climbed 125% in that time.
One school of thought says the new development focus will prove negative for property developers.
The argument goes that funding will need to come from somewhere for the new initiatives, and that may starve the real estate sector. Others counter that rising incomes will boost demand for upgrading housing.
“The proposal has sparked heated discussion,” Peng Wensheng, chief economist at China International Capital Corp, wrote in an Aug 10 note on the dual-circulation proposal.
Peng’s CICC colleagues including analyst Hanfeng Wang wrote earlier in the month that import substitution may become a key trend, with policy makers paying greater attention to security, resilience and effective control of its supply chains.
Given the importance of capital markets to financing industrial innovation along with expanding household wealth, it’s also worth watching leading securities firms, exchanges and investment management companies, according to CICC.
But for now, it may pay to watch for further details from policymakers.
“Investors in China have become accustomed to following the party’s lead, as it often proves to be quite lucrative in the end,” said Hao Hong, chief strategist at Bocom International. “After all, if you’re gambling in a casino, don’t you have to play by what the gaming hall operators say?”
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