On a quiet residential street in eastern China, two green vehicles face off. On the right, a mint green Volkswagen Santana popular in the 1980s: a compact, boxy, 4-door sedan that epitomises the decade China opened up to the world. On the left in a darker shade of green, a bulky 6-seater by Li Auto, a domestic electric vehicle (EV) brand not yet a decade old, which aspires to address middle class affluence by catering to everything from school runs to ‘glamping’ in the countryside. Both these cars were ‘made in China’, but only one — the glittering EV — could claim it is ‘made by China’.

When the Santana was assembled in Shanghai for the first time in 1983, China’s GDP per capita had not yet reached USD $300. In the 10 years that followed China became the ‘factory of the world’ — the dominant player in low-cost manufacturing — while consumers in developed markets enjoyed the cheap prices of Chinese products. By the time Li Auto was founded in 2015, however, things had gone off script. The West’s manufacturing base was hollowing out, with companies scrambling to catch up with their Chinese competitors’ innovative edge in new industries, such as EVs. China became a lot richer, with GDP per capita that year above $8,000, but it had also become a manufacturing juggernaut whose output dwarfed domestic demand. The Chinese economy needed a new solution — from outside of China.

Made by China

An early mover in China’s overseas quest was Fuyao Glass, the world’s largest glass maker, which now occupies 30 per cent of the US market and 20 per cent of Europe’s. Today, Fuyao is investing $650m to expand its plant in Ohio, according to Eric Tse, autos analyst in Hong Kong. But that’s just the tip of the iceberg. CATL, the world’s largest EV battery maker, runs factories in Germany and Hungary, and it is joining forces with Ford to set up shop in the US state of Michigan. A competitor, Gotion, plans to build a factory in the same state and another in Illinois; its German plant went into production in September. In the same month, EVE, a smaller battery player, established a minority-owned joint venture to enter the US market.

The success of these companies, in spite of the Chinese economy’s struggle last year, suggests that China’s growth drivers are becoming more diverse as policymakers try to redirect resources to more efficient industries, and move the economy away from the dominant real estate market. Successful investors are looking beyond the headline numbers to find the winners. More myopic observers, focusing only on the lacklustre performance in overall exports, might have missed the stunning rise in EV exports, as shown in the following chart.

Going for good?

Admittedly, some of the favourable conditions are short-term. Executives at a tier-1 German glass solution company tell us they prefer Fuyao over European suppliers, because the Europeans simply cannot compete on value for money when energy input costs on the continent remain high. Cheaper steel prices in China elevated overseas profits at a forklift maker based in eastern China to 70 per cent of all its earnings, when overseas sales only made up a third of its revenue, implying that the company is eking out wider margins abroad. The catch is that the cycle could turn in the other direction just as quickly, and it may have started already. Euro area inflation stood at 2.9 per cent in December, near a two-year low, as energy prices gave up earlier gains.

Where the Chinese advantage could be easier to defend is in industries with less flexible capacity, such as chemicals. Several European producers of titanium dioxide (a chemical used in everything from paints to sunscreen) have shut down plants in Italy and Germany this year due to high energy costs, leaving a Chinese producer, LB Group, with a windfall in market share. LB Group now expects 70 per cent of future delivery to be exports, up from the historical average of 50 per cent.

Chinese companies are no longer just churning out goods for global customers from the factory floor; they are bringing ashore entire business models. Launched last year, Temu, the international operation by Chinese ecommerce giant Pinduoduo, has attracted more monthly active users (MAUs) than Walmart, and could soon overtake eBay. It was the most downloaded free iPhone app in the US in 2023, according to Apple. “Temu is a very different animal to traditional exporters,” says Sherry Qin, internet analyst and portfolio manager in Hong Kong. “It runs on an asset-light model and does not take inventory risks.” Given that China is the largest ecommerce market in the world, it is possible that more competitive Chinese firms could follow in Temu’s footsteps.

New hope at home

While business is less buoyant back at home, domestic tourism is now stronger than it was before the pandemic. Fidelity’s analysts in China believe Chinese consumers are keen to spend but they want more value for money. At Miniso, a pound shop-style retail chain, net profit jumped over 160 per cent from a year ago in the second quarter of 2023. Sell-side analysts’ forecast was 12 per cent. Sensing more ‘downgrade’ demand, the company plans to open almost 1,500 stores before 2027. Its share price rose more than 90 per cent in 2023. Online, consumers are turning to ‘white label’ products, sold directly by manufacturers. A more receptive consumer base coupled with the proliferation of livestreaming sales on video platforms such as Kuaishou and Douyin (China’s version of Tiktok), are allowing manufacturers to cut out their distributors and pass on the money saved to consumers.

Astonishingly, this trend of trading down reaches even the high end of the price spectrum. Some automobile buyers who have previously been attracted by the prestige of European marques like BMW, Mercedes or Audi are now turning to local EVs, such as that Li Auto 6-seater we began with. “For as little as RMB 300,000, you could get a 6-seater Chinese EV. You’d have to spend at least RMB 200,000 more for a top tier European EV,” says Eric Tse, the autos analyst. “That’s a big plus for better-off families in this economic environment, especially those with three generations to transport.” Shares in Li Auto rallied over 80 per cent last year.

The rest is politics

Perhaps the biggest unknown for investors is not economic, but political. While China’s consistent investment in the EV ecosystem has won Chinese firms market share and a technological edge, it has also drawn unwanted attention. The European Union said in October it will investigate whether Chinese subsidies for EVs are legal, threatening to slap tariffs on these imports. In the US, CATL’s Michigan plant with Ford is on pause after lawmakers criticised the project for being opaque. The Chinese and US presidents met in November 2023, which is stabilising for bilateral relations, but it is unclear if Chinese companies will get any respite, especially with the US presidential election in 2024.

Corporate politics within China is no less challenging. Regulators are putting pressure on state-owned enterprises (SOE) to improve shareholder returns, which investors have taken on face value as a bullish signal. But Fidelity’s engagement with SOEs shows the many pitfalls that may yet cripple reform. Managements are demanding to link their compensation with shareholder return through stock options. That would be politically unfeasible while many SOEs are trading below book — the reason they were put on notice by regulators to start with — as it would constitute a transfer of state assets on discount.

End of an era

China investing used to be straightforward, if not simple. If real estate did well, it would lift many boats in the economy, from construction to consumption. The opposite was true, too. Investors could coalesce around a handful of top-down narratives, such as the rise of the private sector or the digital economy a decade ago, and make decent returns by investing in industry leaders. As this story demonstrates, that era could be ending. Instead, the new vanguards of growth come from all walks of life, some with little to do with the domestic economy. China may end up with a situation where headline numbers are down, but more companies and sectors continue to improve. There will be no shortage of opportunities for alpha in this vast market, but to capture them, many investors will have to rethink their approach to picking winners in China.