China’s GDP is changing, and creating new investment opportunities. Thornburg PM Lei Wang discusses the outlook for Chinese stocks, the market implications of the political turmoil in Hong Kong and prospects for European equities.

Q: China’s central bank has provided considerable monetary and macro-prudential measures to counter slowing growth, alongside fiscal stimulus such as tax cuts. Yet the country’s GDP growth is still expected to decline to 6.1% this year from 6.6% last year, and to ebb a bit more in 2020. Early in your career, you worked at the People’s Bank of China, or PBOC, as the central bank is known. Do you think the latest round of easing will stabilize growth? Does China need a trade truce with the U.S. to stop growth from slipping more? And what are the implications for investors if a trade deal isn’t reached soon?

LW: China’s true GDP growth is a million-dollar question. Gauging it is both art and science. The bigger picture is one of double-digit headline GDP growth 10 years ago falling to mid-single digit growth nowadays. It will likely decline further to perhaps less than 5% in coming years. Whatever the exact number, though, keep in mind that growth a decade ago came off a much lower base in absolute terms: in 2010, China’s economy was about a quarter of its size today. And at $14 trillion, it’s now the world’s second-largest economy after the U.S.’s $20 trillion GDP. A larger base means the headline growth rate naturally declines.

More importantly than sheer size, China’s economy has been shifting from a heavy reliance on infrastructure, fixed investment, manufacturing and exports to more domestic consumption and services. So the quality and sustainability of GDP growth have improved with the economic diversification. It’s also possible that China’s actual GDP growth could be under-reported, given a booming services industry and the lag in the modernization of the government’s data collection system, which may not accurately capture the full contribution from the services component of GDP.

The trade dispute is certainly an overhang for both the U.S. and China. It impacts China more, though, because China’s massive export platform still needs U.S. consumer markets. That said, now that the PBOC has brought China’s shadow banking system under tight control, it has more flexibility to ramp stimulus policies if the trade negotiations stall. In fact, a macro-cyclical recovery could be in the cards next year, given easing financial conditions, a stabilized currency exchange rate, and low domestic inventory levels. In my opinion, that backdrop should support a decent return for Chinese equities, even after the blue-chip CSI 300 Index has gained nearly 30% so far this year. As for portfolio exposures, we like select Chinese companies focused on the domestic market as their earnings don’t really depend on exports.

Q: The protests in Hong Kong have taken a toll on the island’s retail and leisure segments, as visits from mainlanders have dropped precipitously. If the uncertainty undercutting Hong Kong-listed stocks is running high, are areas of the island’s equity market being overly penalized amid the broader declines?

LW: The situation in Hong Kong is very volatile and the political complexity is far greater than the televised images of protesters and police might suggest. I hope authorities in Hong Kong and Beijing de-escalate the crisis and assure Hong Kongers that the island’s future is still bright. Otherwise, Hong Kong’s future could become very gloomy, as it could lose its regional status as an offshore financial and commercial hub into China. Business could move to Shanghai, Shenzhen or even Singapore.

On the investment front, Macau gaming companies could well benefit as tourist flows draw away from Hong Kong. Valuations of insurers listed in Hong Kong have become very attractive; these firms aren’t as impacted by the political strife as some might think. That’s because many financial transactions are executed online rather than offline in physical offices. Property and infrastructure developers with operations and assets in the mainland are also now trading at attractive valuations, as are Hong Kong-listed telecom stocks with exposure to the mainland. And, of course, stock and futures exchanges always benefit from market volatility, which translates into higher trading volumes.

Q: Although you’re a bottom-up investor, from a geographic perspective you currently have higher-than-benchmark exposure to continental Europe, but less so to the U.K. Can you broadly speak about where you’re finding attractive opportunities and why the U.K. is perhaps less attractive at this time?

LW: We will probably remain overweight mainland Europe over the coming year. As we discussed earlier, I think the Chinese economy is stabilizing and Chinese companies will likely begin re-stocking next year after low inventory levels this year. That will benefit Germany and the rest of continental Europe, as China is their largest export market. A relatively weak euro should also be a tailwind for European exports.

We have been underweight the U.K. for three years now, given in part the political uncertainty around Brexit. But some sort of resolution should become clear in the coming months. Our research on a number of individual names is revealing some quite attractive opportunities, particularly among U.K. financials and other types of domestically focused cyclicals. So that underweight positioning could be reversed in the not distant future.

Q: That brings up a current question on a possible rotation from growth to value stocks. After a long run in which growth-classified stocks have outperformed value-tagged stocks, do you see value stocks entering a period in which they take the lead?

LW: While value may be outperforming growth lately, those familiar with our investment process understand our unique three-basket approach, which we think optimizes portfolio diversification and rebalancing. The balanced mix between growth and value styles helps us, whichever way the wind blows, whether toward value or growth or quality compounders. That means we don’t have to try and time the market, which is very difficult. The baskets can help us limit the downside in falling markets and participate in subsequent upswings, and in turn helps us compound off a higher base.