Q&A: Reckoning with China

Lord Abbett director of strategic asset allocation Giulio Martini talks about China’s sizable influence on the global economy—and what that means for investors. 

While China is a long-established economic superpower, some investors may not realize just how significant the country is in terms of global growth, according to Lord Abbett partner and director of strategic asset allocation Giulio Martini. China’s economic influence—both in its own backyard and in more far-flung nations—carries some surprising investment implications. Against a backdrop of U.S.-China trade tensions and ongoing concerns about China’s economic growth rate, Lord Abbett product consultant John George sat down with Martini to address these and other topics. Edited excerpts from their conversation follow. (Visitors to lordabbett.com can view a related video or listen to a podcast version of this conversation.)

Q: What might people be missing about China’s impact on the global economy?

A: People know that China is a very large country. It's 1.3 billion people, roughly. And I think they know that it's been growing rapidly for a very long period of time, roughly 40 years. What that's done is taken China to the point where it's the biggest driver of growth in the global economy.

From 2014 to 2018, 50% of the growth in global gross domestic product (GDP) in U.S. dollar terms came from China. That's an enormous proportion for a single country. And what that means is that growth in China spills over directly into the rest of the world. If growth is decelerating, it's going to be felt all across the globe, in diminished demand for imports. And if growth is accelerating, it's going to have the opposite effect and radiate out very quickly into the rest of the world, in a very noticeable way.

Q: You cited some data points for China’s economy. How much can we trust that data that's coming out of China?

A: I think when it comes to data, people have to remember two things. One is that for most of its modern history, China has been a very poor country, so its data architecture is very sparse. The second thing is that it's an authoritarian system, and so, in many cases, the incentives that officials have to report data are influenced by what they think the government wants to hear.

So, people are rightly skeptical about data from China. For example, in measuring GDP, much of the data that in the United States would be reported through sample surveys—through actual, sound data collection, and thus used to estimate consumer spending or investment spending—does not exist in China.

And so, Chinese growth is estimated from very irregular surveys, and in the interval between those surveys, it is smoothed. Now that's a reasonable practice, but it results in economic growth numbers that look excessively smooth, compared to other countries.

The good thing about China, though, is that that's not the only data available. We do have some data on hard commodity production. We have auto production numbers. And more importantly, because of China's big impact on other countries, we can see, for example, what its exports to Korea are doing, or what China's imports from Korea or from Taiwan or from Vietnam are doing.

And if those imports are growing, we can see the effect by observing what's going on in those other countries. If they're falling, we can see the verification from those trading partners. So even though the Chinese data directly may not be as informative as we'd like them to be, we can still see the impact that it has on other countries to infer what's going on in China itself.

Q: Can you talk more about China’s strategic importance in its own region, and beyond?

A: Well, China's really a dominant influence on economic growth in a country like Korea. South Korea is a very open economy, meaning it's highly influenced by trade. Eighty percent of Korea's economy is made up of imports and exports, so what goes on in the rest of the world has a big effect on Korea.

But because Korea is really part of a supply chain that runs through China, one that supplies the world with much of its tech and telecom equipment, the share that goes to China is disproportionate. So, over 50% of Korea's trade is with China itself, which means you have a very direct impact running from China to Korea. It's very similar for Taiwan, Vietnam, Hong Kong, and other economies in the region.

In northeast Asia, China is really the dominant driver of economic growth and of the business cycle. In the rest of the world, it's somewhat less influential. But when you look back in the recent past, the times when China has gone from relatively modest growth to faster growth have radiated out immediately, especially into Europe, but also into South America, and into commodity producers as a whole.

Q:  Tell us about the current investing landscape, and where the greatest China-related opportunities may be.

A: The analogy I would draw is to late 2015–early 2016. China was in a weak-growth period, and then took steps to stimulate its economy through directing credit to the housing sector and to other industrial sectors, and growth started to pick up.

And what happened in early 2016 is that global trade started to pick up as China recovered, and that produced a stronger economic recovery in Europe. It also created a stronger economic recovery in the United States and in the emerging world, and as companies did better and earnings revisions turned positive, equity markets did extremely well.

So, right now we've gone through a period where China's had some weakness related to cutting down on credit growth and trying to reduce risk in its financial system. But Beijing recognized that that went a little too far over the summer of 2018 and it started to implement a series of stimulus measures, which now seem to be coming through and producing better economic growth.

And if that's true, then we should very shortly start to see once again a recovery in global trade, with benefits primarily for Europe—because it is so weak—but also for emerging economies as a whole. The other thing that I want to point out is that the way investors have benefited from China, somewhat paradoxically, has not been by investing in China or in Chinese companies directly, but by investing in other parts of the world that are very strongly affected by what's going on in China itself.

So, for instance, global mining companies, particularly Australian ones, have grown tremendously, and grown their profits enormously, because of the increase in commodity demand from China. Global shipping companies have benefited greatly as China's role in global trade has grown.

So, there's a whole range of things that China affects—even property companies right here in Jersey City have benefited from building by Chinese investors. And so tracking down the footprints of China's influence in other countries has actually been a much more profitable way of taking advantage of what's going on in the country than investing directly in China itself. That's something to keep in mind as we think about how to respond to what will continue to be the growing influence of China in the global economy.