COLUMN-Investors who sleep on China may wake up too late: Pelosky

The views expressed here are those of the author, the Founder and Global Strategist at TPW Advisory.

By Jay Pelosky

Jan 28 - While much of the global financial community was glued to the latest plot twists in the Trump 2.0 show in recent months, investors would have been wise to pay more attention to what was happening on the ground in China.

Some money managers have described China as ‘uninvestable’ over the past year, based on fears that China will face further deflation, deterioration in its struggling property sector, additional tariffs from Donald Trump’s new administration, a potential debt bust, and even ‘lost decades’ of economic stagnation.

But I beg to differ.

The above concerns ignore significant shifts occurring in the global economy. I have argued that global growth in the coming years will be driven by industrial policy-based competition in a tri-polar world with nodes in North America, Asia and Europe. In this environment, fiscal space and governance capacity will likely be key.

And China appears to have the capacity and the political will necessary to provide massive fiscal stimulus, drive domestic consumption, and support the development of key industries.

While the U.S. debt-to-GDP ratio has jumped from roughly 110% in 2019 to more than 120% today, Beijing’s central government debt burden has only risen modestly to around 60% at the end of the third quarter of 2024.

China has also been successful in deploying industrial policy – its ‘Made in China 2025’ program – to become the dominant player in several pivotal emerging industries, especially climate mitigation.

How successful? China led in just three of 64 critical technologies between 2003 and 2007, but then became the lead country in 57 of those technologies between 2019 and 2023, according to the Australian Strategic Policy Institute.

‘SPLINTERNET’

Today, artificial intelligence represents the epicentre of global competition.

The U.S. has sought to boost its own AI industry, most recently with the Trump administration’s call for up to $500 billion in investment in AI infrastructure.

At the same time, the U.S. government has sought to limit China’s access to cutting-edge semiconductor chips and equipment, including by adding many Chinese companies to the U.S. Commerce Department’s Entity List, which restricts the goods and technologies these companies can receive.

This ‘splinternet’ strategy hasn’t stopped China’s AI capacity from improving rapidly, as the investment world recently learned.

Global technology stocks have been roiled by the revelation that DeepSeek, a Chinese AI company, has developed a large language model that is widely considered to be on par with the top U.S.-developed LLMs, despite being created at a fraction of their cost.

Meanwhile, recent U.S. policy actions targeting Chinese companies have not dramatically impacted Chinese equity prices overall. Indeed, as Joe Biden prepared to step down as president, he added dozens of additional Chinese entities to the restricted list, yet China-focused ETFs like FXI and KWEB barely reacted.

And the ‘splinternet’ cuts both ways. China’s tech space increasingly appears to be reserved for Chinese companies, with many U.S. tech giants recently ceding market share. Apple is now in third place behind two Chinese firms, after its sales in China fell by 18% year-on-year in the fourth quarter.

MISPLACED FEARS

Despite all the hand-wringing about China’s recent economic performance, large-cap Chinese equities, as represented by the U.S.-listed ETF symbol FXI, actually outperformed the S&P 500 last year in USD terms. And the Chinese bond market rallied sharply over the year, meaning many China-based 60/40 stock/bond portfolios would have outperformed their U.S. equivalents.

At the same time, Chinese equities have appeared cheap on both an absolute and relative basis. The average price-to-earnings ratio for U.S tech stocks was roughly double that of their Chinese counterparts at the end of 2024.

True, China’s $1 trillion trade surplus with the U.S. makes it an easy target for Trump’s tariffs, and China’s net exports were responsible for roughly 25% of its GDP growth last year, creating more vulnerability. However, China has diversified away from the U.S. market in recent years and now exports more to Southeast Asia than to the U.S. And Trump has recently suggested he could soften his stance on Chinese tariffs.

Even if he changes his mind, the projected impact of the previously threatened 60% tariffs on all Chinese exports would take barely 1% off China’s annual GDP growth, by some estimates.

WHERE THE PUCK IS GOING

Many investment banks have suggested waiting to allocate to China until the tariff picture clears up. This line of thinking is reasonable, but when the ‘all clear’ sign finally does arrive, it could create a rush into Chinese equities that leaves many playing catch-up.

Investors should instead consider the advice of National Hockey League legend Wayne Gretzky: skate to where the puck is going, not to where it has been. In today’s global economic environment, the puck is likely to go to countries that have the ability and willingness to successfully execute the type of industrial policy that can boost economic growth and corporate earnings. China fits that bill.

(Jay Pelosky is the Founder and Global Strategist at TPW Advisory, a NYC-based investment advisory firm. Jay is the creator of the Tri Polar World (TPW) framework and the Global Risk Nexus (GRN) system.)