The old investment playbook – which relied on China’s multi-year, near-double-digit economic growth; investments into infrastructure and property; and global manufacturing dominance to sustain it – is no longer relevant. Instead, China’s economic growth headwinds continue to be splashed across front page news, with headlines like “Xi’s failing model”, “China’s fading economic miracle and disillusioned youth”. Rather than dominating global growth through 2023, as hinted at by the International Monetary Fund (IMF) in Q1 2023, China is floundering under an alarming debt burden and changing demographics.

Underestimated economic implications

Given the size of China, and its importance to South Africa, we need to start paying significantly more attention to China’s economy than we do the United States.  Importantly, the macros that have driven the Chinese economy over the last two decades are unlikely to continue to drive it over the coming years; and that has significant consequences for South Africa.

China is facing some fundamental structural issues, starting with its demographics. In the 1970s, the county boasted a near-perfect balance between young and old; today the pyramid is all askew, with an ageing population and a low birth rate. There are fewer workers to power the manufacturing sector, and nobody to buy the thousands of homes built during the debt-fuelled property boom.

China’s property sector, long an underpin of its economic growth, is faltering. At its peak it made up 32% of GDP, today it is at levels last seen in the early 2000s, around 24%. Property as an investment vehicle is now being questioned in China. In addition, its economic model now needs to change from being manufacturer intensive to consumer intensive. These changes will have a significant impact on South African investors, given that around 35% of JSE Top 40 revenues derive from Asia / Middle East for total revenues.

Commodities conundrum

China is one of South Africa’s major trading partners; but a waning Chinese economy has a far greater impact than simply affecting our trade balance. At present, Chinese demand for major commodities like aluminium, copper, iron ore, nickel make up more than 50% of global markets. Any fall in demand for commodities is bad for commodity producers like Australia, Chile and South Africa. In South Africa’s case, a slowdown in Chinese commodity demand – and decline in commodity prices – results in a drop in export revenues and tax revenues.

The contribution of commodities to South Africa’s income tax and royalty revenues is starkly illustrated by the tax contributions of the 15 largest mining companies. Their tax contributions are forecast to fall by almost half in 2023, from R90 billion in 2022 to around R48 billion (and well short of the 2021 windfall of R110 billion). The story worsens in 2024, with a further 10% decline in estimated tax revenue collection to just over R40 billion. However, the South African revenue authorities are not the only one’s feeling the commodity price pinch.

Playing China through the resources companies is going to be less relevant and less profitable going forward. Over the last five years, the best way to earn returns through the JSE (as affected by China) has been via the resources sector; but slowdown in China’s motor vehicle manufacturing and property investments and ongoing ‘shift to green’ are forcing a re-think.

A new approach is needed, with companies such as Naspers and Richemont being more likely to dominate future ‘plays’ on the Chinese market. This is because firms with exposure to the Chinese consumer theme are preferred over resources, as they will benefit more as that economy transitions away from infrastructure-led growth.

Selective opportunities

However, if you look back over the last 40 to 50 years you see plenty of bad-news-driven pullbacks, yet our market has delivered returns amidst this noise through the decades. This indicates that opportunities for returns do still exist for the selective investor.

Against this backdrop, our preference is for a cautious equity strategy, with a higher weighting to global defensive and technology shares, and gold, and a move away from resources and telecoms.

The focus is on finding firms that will prove resilient, regardless of the macroeconomic constraints. For shares with global revenues, the likes of Anheuser-Bush; British American Tobacco; Naspers; and Richemont are on the radar. As for South Africa Inc, local banks remain attractively priced, as are defensive retailers such as Spar and Shoprite and clothing retailers such as Foschini and Mr Price. DM/BM

By: Siboniso Nxumalo, Chief Investment Officer, and Meryl Pick, Head of Equity Research, Old Mutual Investment Group