Investing in a Transformed China

China’s transformation into a consumer-powered economy from an export-driven model has been playing out for many years, but it still has a long way to go. According to Morgan Stanley Research, private consumption will almost double to $9.7 trillion by 2030, from $4.4 trillion in 2016. President Xi Jinping, who has been driving this transition, was recently chosen for another five-year term, which suggests continuity.

Personal Consumption on a Steady Climb in China

Given the upbeat outlook, Morgan Stanley Wealth Management has identified several long-term themes to help investors gain exposure to the changing Chinese economy.

Spending on travel, entertainment and leisure will likely increase, as China attains high-income status. Per capita income is expected to grow to $12,900 by 2027, up from $8,100 today, according to Morgan Stanley Research estimates. We favor high-quality media companies that own theme parks; in 2016, attendance at China’s existing parks grew by 8% and new parks saw nine million visitors.

Additionally, we like premium-liquor manufacturers. Morgan Stanley AlphaWise, which conducts evidence-based investment research, expects 8% annual volume growth in China through 2020 and also thinks that the broader spirits market profit pool will expand to $12 billion in that time frame.

Manufacturers of smartphones should benefit, too, given likely pent-up demand for their new products. Morgan Stanley's lead technology hardware analyst, Katy Huberty, forecasts accelerating upgrades will drive 66% unit growth in 2018 for one leading smartphone maker. While Chinese internet companies are beneficiaries, given some 700 million users, these companies have done exceptionally well this year and valuations are no longer compelling.

With the government focus on value-added manufacturing and a connected industrial ecosystem, we see opportunities for semiconductor makers that provide chips for factory automation and infotainment in autos and telecommunications. On factory automation, we note that China’s industrial robot demand accounted for 31% of global demand in 2016, and the International Federation of Robotics has estimated 21% average annual growth for the Chinese market from 2017 through 2019.

Despite slowing global demand for cars, Morgan Stanley analysts see Chinese auto parts and semiconductor companies as best positioned to capture growing demand in the auto electronics market, which is expected to almost double to $200 billion between now and 2020. Semiconductors are also powering the 5G wireless cycle, which is expected to provide faster connections and a 20-fold improvement in efficiency over existing 4G technology. China’s 5G projects are forecasted at $450 billion through 2030.

The lack of a consumer safety net, as well as significant air- and food-quality issues in major cities, have been impediments to higher consumer spending in China. That is changing, however, as the government invests in environmental improvements. According to the U.S. Environmental Protection Agency, China accounts for one-third of global carbon dioxide emissions. Improving environmental conditions, food safety and health care have become top priorities within China’s 2016-2020 economic development plan. In fact, the budget for environmental projects is double what it was in the previous plan, making China a critical driver of global spending growth in these categories.

We favor select life-science device companies that manufacture sophisticated testing equipment to improve air and food quality. Notably, we have seen the government pay up for U.S. and European products because they cannot yet more cheaply replicate the technology.