2024 Outlook: Greater China Equities

Identifying megatrends with structural opportunities

Mainland China remains the world’s second-largest economy. Despite slower-than-expected consumption growth, the concerted rollout of fiscal, monetary, and property-related policies may improve Mainland China’s economy further in 2024.

During Mainland China’s Politburo meeting in December 2023, its leadership pledged to “effectively promote the economic recovery and achieve reasonable quality growth.” Policymakers also emphasized “strengthening counter-cyclical and cross-cyclical adjustments.”¹ Mainland China’s economy has improved throughout 2023, especially its service-oriented sectors, which has offset weaknesses in the country’s manufacturing Purchasing Managers’ Index and pressure from the property sector. With a positive, pro-growth stance, we think it’s supportive of economic growth in 2024. 

We believe company earnings in Mainland China and Hong Kong have now stabilized and therefore expect earnings growth for the MSCI China Index to rise by 12% to 15% year over year.

In regard to the Taiwan market, we remain positive on the technology sector, given its strong competitive advantages regardless of whichever party wins the election. If the more Mainland-China-friendly opposition party takes office, we believe nontech sectors could benefit.

Four megatrends and our expectations for the Greater China market going into 2024

We’ve identified several growth drivers emerge (we call them the 4As) that would guide investors to navigate the evolving investment landscape.   

1 Acceleration: consumption may further improve with Mainland China’s pro-growth policy stance

Throughout 2023, Mainland China’s household consumption recovered to slightly above prepandemic levels. Notably, the service-oriented sector recovery is very apparent after the country’s reopening.

Meanwhile, household incomes rebounded in 2023 versus 2022 (i.e., people are becoming wealthier); however, the recovery is slightly below trend due to weaker-than-expected income growth and weaknesses arising from a deflating property market. As a result, softer-than-anticipated consumer confidence has held back consumer spending. Since July 2023, Mainland China has stepped up its efforts to support the country’s property sector with policies such as reducing down payment ratios, removing home purchase restrictions, and lowering mortgage rates. We believe more targeted measures will be required in 2024 to continue supporting the property market.

2 Expanding abroad: leading Chinese companies are going abroad—another growth engine

Leading Chinese companies are going abroad in recent years, which will be another new growth engine. Over the past decade, Mainland China’s outbound direct investment (ODI) has more than doubled. Between 2016 and 2017, regulators tightened the supervision of capital flows and private companies’ overseas investment transactions. The impact of the pandemic, coupled with geopolitical tensions, also weakened ODI in 2022; however, ODI has significantly improved since Q1 2023, and we expect the trend to continue, especially with Chinese companies’ desire to go abroad and capture overseas market share to achieve further growth potential. In addition, we believe ODI flows will improve further, led by private enterprises and a greater focus on strategic industries that support Mainland China’s broader policy initiatives.  

Chinese companies are strongly incentivized to go abroad and expand their foreign market share through direct investment. These are the major reasons: 

• To gain access to critical materials (e.g., lithium, copper, nickel, cobalt, and rare earth metals) through direct investment rather than imports, providing greater autonomy over management and operations
• To achieve revenue diversification
• To leverage better cost structures (e.g., cheaper labor costs, access to local manufacturing benefits) in overseas markets

We’re positive about companies that can compete in foreign markets with competitive products, cost leadership, and benefit from economies of scale. We favor leading Mainland Chinese companies that could boost domestic substitution by gaining local market share from global brands.

3 Advancement: the AI supply chain in Greater China continues to see robust growth in 2024

Mainland China strives to accelerate its technology road map. We believe we’re currently in the early stages of the AI era, and Greater China (especially the Taiwan market) still has ample opportunity to grow. In addition, Mainland China owns many intellectual property (IP) patents in computer technology compared with the rest of the world.

Furthermore, the Taiwan market benefits from the growth in AI development as it possesses strong semiconductor fabrication capabilities, with world-leading foundry processes (ranked first ahead of South Korea and the United States).  

In addition, the Taiwan market has a comprehensive global technology supply chain. Its one-stop supply chain ranges from foundry, integrated circuit design, and IC packaging and testing to integrated device manufacturing and semiconductor material and equipment. With a vertically integrated supply chain, the market leads its global peers in terms of manufacturing, cost, and efficiency.

4 Automation: Mainland China’s aged population² may lead to higher demand for automation

The Chinese government has continued to support niche areas in advanced manufacturing. In early November 2023, the Ministry of Industry and Information Technology issued a guidance opinion on the development of humanoid robots, with the key goals to be achieved by 2025 and 2027. By 2025, Mainland China aims to establish an initial humanoid robot innovative system and achieve technological breakthroughs in key components such as robot brains, cerebellum, and limbs to ensure that the components are supplied safely and efficiently. The humanoid robots are expected to meet international standards and be ready for mass production. Mainland China also aims to cultivate two or three globally influential ecological enterprises and several sophisticated and innovative small and medium-sized enterprises, with two to three industry development clusters by 2025.³

By 2027, the technological innovation capability of humanoid robots is expected to improve significantly,³ creating a safe and reliable supply chain system. 

We believe the humanoid robot industry may expand further with broader applications.

To sum up, Greater China’s economic growth path has arrived at an inflection point. The 4As discussed above could guide investors to seek structural opportunities in specific sectors. We provide more details in the next section. 

What are the next big things for Mainland China going into 2024?

Going into 2024, we believe that Mainland China should benefit from the following key areas despite macro and geopolitical headwinds:

1 Traditional technology
2 AI
3 Advanced manufacturing
4 Electric vehicles (EV)
5 Healthcare

1 Traditional technology: the global smartphone market is expected to recover in 2024

We believe the global smartphone market has passed its worst point and the current recovery trend will continue in 2024, supported by several catalysts:

• Smartphone inventory destocking has occurred since Q2 2022 and the cycle is largely complete.
• Early signs of recovery were seen, with a rush of orders in Q3 2023 on the back of lean inventory. These orders showed a pickup in demand.
• More AI applications and use cases for mobile applications will emerge over the next few years. Edge AI⁴ and related components are required, given that edge AI requires a new-generation system on a chip (SoC) with custom AI modules.

Smartphone original equipment manufacturers (OEMs), memory manufacturers, and SoC component makers will be the key beneficiaries of the adoption of edge AI, which is expected by 2025. Memory manufacturers benefit from the memory upgrade as large language models (LLMs) are used in AI, which require higher data processing capabilities. Camera-related component companies (e.g., lens, complementary metal oxide semiconductor) will also benefit from specification upgrades.  

Furthermore, we’ve seen leading Chinese smartphone players advancing their road maps on technology innovation. A major Chinese smartphone giant has consistently gained market share over the past four to five quarters with technology breakthroughs in hardware specifications. Another Chinese smartphone leader invested in the research and development (R&D) of an on-device LLM, which has enabled the company to enjoy a first-mover advantage when edge AI takes off.   

2 AI

Looking at the landscape, Mainland China’s internet platform companies remain active with computing technology and AI investments despite headwinds from the United States such as export controls on AI, quantum computing, and semiconductor-related products to Mainland China that target data centers and military applications. 

As for the semiconductor industry, we believe AI developments will continue, especially as the Chinese government remains supportive of semiconductor initiatives. For example, the China Integrated Circuit Industry Investment Fund, known as the Big Fund, is set to launch a US$40 billion investment fund backed by the Chinese government to support the manufacturing strategies of domestic semiconductor companies. 

With technology self-sufficiency, we believe Mainland China’s domestic semiconductor supply chain has various opportunities for future growth, ranging from upstream to downstream.

Mainland China is well positioned to capture the packaging and testing market in the supply chain for back-end semiconductor equipment.

Currently, most chip packaging (73%) uses traditional wire bonding even though this technology is older and less efficient. Advanced packaging (AP) involves packaging micro-bumps, redistribution layers, and through-silicon via (TSV), which uses a vertical electrical connection that passes through a silicon die or wafer, or wafer-level technologies. AP enables more transistors and memories to be integrated on a die using 2.5D/3D packaging, which vertically stacks components. The AP market could grow at a compound annual growth rate (CAGR) of 10.6% from 2022 to 2028, driven by demand for high AI chips.⁵

3 Advanced manufacturing

Three trends for Mainland China industrial

• Capital expenditure (capex) for industrial general equipment cycles bottomed out in late 2023, but the recovery has been delayed into early 2024. 
  
  We believe the demand for generic industrial equipment has bottomed out and is improving on the back of stabilizing macro conditions as inventory destocking is mainly complete. We also think the capex cycle bottomed out in 2023, but its recovery has been delayed into 2024 (although it could be sector specific).

• Domestic substitution continues as Mainland China’s leading players gain market share through stronger price-to-performance propositions versus foreign imports
  
  We see bright spots in auto-related segments: Supply chain companies are actively adding new capacity to cater for demand from auto customers in Mainland China. The addressable market for Mainland China’s advanced manufacturing is broad, with products ranging from automation, industrial robotics, and rotary-vector reducers to X-ray machines. With higher value-add and more sophistication built into products, Mainland China’s industrial manufacturers are rapidly expanding their capacities with robust revenue growth. We believe localization rates across many industrial subsectors could grow by 50% to 100% by 2030.

• Mainland China’s industrial component companies continue their robust growth with overseas expansions
  
  Another growth driver that Mainland China’s industrial companies are pursuing is globalization strategies. Following the expansion footprints of Chinese new-energy vehicles, OEMs, and EV component manufacturers are also building manufacturing plants in Europe and LATAM (i.e., following their customers).  

4 EV

Export growth is a bright spot

Export growth has been a bright spot for Mainland China’s EV sector. According to the China Passenger Car Association, 740,000 units of new energy vehicles were exported to Europe in the first nine months of 2023 versus fewer than 10,000 units in 2019 (i.e., >70x growth). Also, more than half of Mainland China’s EV shipments now is headed for Europe, as opposed to less than 10% before 2020.    

Despite the European Commission’s investigation into whether Chinese EV makers benefited unfairly from state subsidies, it’s worth noting that Chinese brands make up only 3.7% of all electric cars sold in Europe (this still represents a significant level of growth from 0.4% three years ago).      

One leading EV company focuses on building a vertical supply chain by producing 70% of its own auto parts, including major components such as batteries, motors controllers, and semiconductors. This gives the company an edge as it can compete on cost globally. By building out manufacturing plants worldwide, the company can maintain supply chain resilience while efficiently and effectively managing production and product delivery logistics.

EV component manufacturers are also beneficiaries

In addition, many Chinese auto brands bring their technical know-how and EV supply chain experience to European markets. The current gap between Mainland China and Europe exists upstream such as in raw material processing and battery manufacturing.

Globally, Mainland China commands more than 75% of global battery-making capacity, whereas Europe only has around 8% of capacity. Therefore, European auto manufacturers still rely on batteries procured from Mainland China for their EV production.

The European Union (EU) aims to phase out fossil fuel cars completely by 2035. Also, the EU has been pushing for the localization of battery production since 2017. Its Net Zero Industry Act in March 2023 aims for around 90% of the EU’s annual battery demand to be met by EU battery manufacturers with a capacity of at least 550GWh by 2030. Therefore, with a significant demand gap to fill, Chinese battery manufacturers could be clear beneficiaries riding on the global EV boom.

5 Healthcare

Mainland China’s pharmaceutical sector was affected by the country’s anticorruption campaign in July 2023. That said, many negative factors have now been priced in. The Chinese government has recently emphasized the promotion of innovative drug development and healthcare system reform. The National Healthcare Security Administration is currently exploring a phased pricing mechanism for innovative drugs across different life stages—for instance, emphasizing drug accessibility during the early stages of the cycle and affordability in the latter stages. This helps promote innovation in the drug industry, especially for pharmaceutical companies with rich pipelines. 

For 2024, we believe the sector should see a brighter outlook on the back of several factors: Mainland China’s pursuit of innovation ranging from high tech to healthcare, the strong pipelines of Chinese biotech companies, and a potential recovery in global biotech investments as interest rates decline.

Pharmaceutical companies with strong future pipelines and global footprints

We favor pharmaceutical companies with strong future pipelines and global opportunities. Several Chinese pharmaceutical companies have invested heavily in R&D with robust, innovative pipelines and broad portfolio exposure. 

Also, we prefer pharmaceutical companies with in-licensing opportunities with global players. Some of the companies we favor have R&D centers across Mainland China, the United States, and Europe, with over 100 drug projects, more than 900 authorized IPs, as well as more than 15 oncology candidates in the pipeline. Some leaders are also exposed to antibody-drug conjugates, an area of focus for the next stage of development.

The Taiwan market: what are the next big things in 2024? 

We believe the major driving forces for the global technology industry going into 2024 include the continued growth of AI development, the recovery of the smartphone market, and the recovery of the personal computer (PC) market.

We see Taiwanese companies benefiting the most in the following areas:

1 Foundries
2 IC-design services
3 Server hardware supply chain
4 Networking switches

1 Foundries: at the bottom of a U-shaped cycle

We believe that the growth of foundries could ride on the recovery of the consumer electronics market and continued AI development.

We believe the semiconductor cycle has exited the deep contraction phase of the past four quarters. Going into 2024, foundries may benefit from the growing localization trend and increased demand from domestic suppliers, and rising AI demand as more advanced node capacity is required. Revenue upside will likely come from the AI-related semiconductor supply chain and server market recovery.

If we look at the historical global technology cycle, PC/internet growth led the technology boom from 2001 to 2005. This was followed by mobile computing from 2006 to 2016 and high-performance computing/AI/5G/Internet of Things from 2016 to the present day. As the Taiwan market commands a unique position in the Asian upstream semiconductor industry, AI semiconductor growth could be a significant growth catalyst for leading Taiwanese semiconductor companies.

Taiwanese companies commanded 66% of global market share for foundries as of the end of May 2023. Going into 2024, leading Taiwanese foundry players should lead the demand recovery of semiconductor upcycles, driven by robust appetite for AI logic semiconductors, for example, graphics processing units (GPUs) and application-specific integrated circuits (ASICs), rush orders from Android smartphone SoC, and central processing unit (CPU) demand on the back of recovering global PC market.

Furthermore, we’re currently at the trough of the logic semiconductor downcycle and believe inventory issues should be largely resolved by Q4 2023. Logic semiconductor revenue is expected to grow by 10% to 15% year over year in 2024.   

The global PC market is expected to recover in 2024

In regard to the global PC market, PC shipments are expected to pick up again, driven by replacement demand and the expected Windows 11 refresh going into 2024. With the end of life of Windows 7 in 2023 and Windows 10 by 2025, corporates will likely upgrade their PCs over the next two years.

2 IC-design services⁶

Another area of significant potential growth for the Taiwan market is the IC-design services industry. IC-design service providers are third-party, one-stop-shop design consultants who assist with front-end and back-end design and manage the fabrication process on the foundry side.  

On one hand, system houses/fabless companies may outsource their chip design and production tasks to IC-design service providers. On the other hand, IC-design service providers receive nonrecurring engineering fees and mass production fees. 

Major customers typically prefer to outsource more IC-design and fabrication integrations to IC-design service companies because outsourcing can help to lower operating costs, provide access to new technologies (e.g., advanced chip packaging and chiplets), and reduce IC development costs with rising demand for IP blocks.

In the past, IC-design service companies focused on ASICs for consumer electronic markets. Over time, these companies have expanded their product portfolios to include AI, HPC, industrial applications, servers, and automotive, among others.    

Within the logic processor market, there are different types of logic chips: standard logic and specific-purpose logic. Within specific-purpose logic chips set, there are a few major types, including:

•  ASICs, which are customized IC designed for specialized applications focusing on one task
• Application-specific standard products that cover multitasking chip categories such as CPU and GPUs
• Field programmable gate arrays 

While multitasking GPUs currently dominate the AI chip market, demand for ASICs is expected to grow at a faster rate than the overall market for the AI semiconductor market. This is because ASICs perform a single task in the quickest and most efficient way, which is useful for handling data-intensive tasks.

In terms of the competitive landscape, Taiwanese companies play a significant role in the IC-design service provider market, given that three out of the top five players are from the island.

According to HSBC research, the global ASIC market is expected to grow at a CAGR of 12.4% from 2021 to 2026. Of these, the AI ASIC market is expected to grow at a CAGR of 69.2%, much faster than the total AI semiconductor market due to the abovementioned reasons. To summarize, the proliferation of AI presents growth opportunities for Taiwanese IC-design service companies, especially those in the custom IC market. 

3 Server hardware supply chain

In addition to foundries and IC-design service companies, the server hardware supply chain is another growth area for the Taiwan market going into 2024.   

Major hardware companies in the Taiwan market are exposed to various parts of the server hardware supply chain (e.g., server original design manufacturers (ODMs), switch companies, and hardware component companies). 

We believe that server market growth will further improve in 2024, driven by the recovery of normal servers and the ongoing strength of AI servers, both of which are significant drivers for Taiwanese ODMs. Global cloud service providers and enterprises are collaborating with Taiwanese ODMs, which possess strong R&D and engineering capabilities with high customization abilities and quality. As a result, Taiwanese ODMs have gained market share from server motherboard manufacturing, server rack/system solutions, and final assembly over the years. 

Over the longer term, the various subsectors of the AI server market should experience the fastest growth among all components (e.g., printed circuit boards, server ODMs, networking). In addition, the estimated AI spend as a percentage of the total data center capex of U.S. and Chinese cloud service providers (CSPs) remains high going into 2024.

In the case of AI servers, ODMs’ value-add comes from higher customization abilities, which enable servers to cope with each CSP’s strategy/strength. The design fee for an AI server is two to three times higher than the regular server rack, according to the top server ODMs. Server ODM players are also the PC/notebook ODMs. Meanwhile, motherboard makers have also entered the server market, given partial product overlaps and long relationships with their major U.S. customers.

4 Networking switches: the migration from 100G to 400G continues

As demand for computational power and networking bandwidth at data centers increases, demand for networking switches also rises. Of note, the white box switch has steadily captured a growing share of the market due to continued component supply improvements and lower enterprise market pricing. We expect 400G switch demand to pick up and believe the market share of the white box switch should continue to grow globally in the coming years as cloud customers look to reduce costs. White box server shares accounted for 38.4% of the total server market as of Q2 2023.  

Globally, there are only a handful of white box switch vendors. A Taiwanese white box switch firm leads in terms of market share (53%), followed by a U.S. company (40%), and other Taiwanese ODM+ switch manufacturers (5%).

Conclusion

As we move into 2024, Mainland China has reiterated its pro-growth stance for the economy. More policy support on the fiscal, monetary, and property fronts should enable the economy to stabilize, which should in turn boost household income and consumption growth further.

Furthermore, we believe the four megatrends (the 4As) continue to drive growth for the Greater China region:

1. Acceleration—Consumption may further improve with Mainland China’s pro-growth policy stance
2. Abroad—Leading Chinese companies are going abroad—another growth engine
3. Advancement—The AI supply chain in Greater China (especially in the Taiwan market) continues to see robust growth in 2024 
4. Automation—China’s aged population⁷ could lead to higher demand for automation

Going into 2024, we favor the following Chinese growth sectors: traditional technology, AI, advanced manufacturing, EV, and healthcare. In the Taiwan market, we continue to favor the technology sector, driven by AI beneficiaries. We prefer the technology subsectors going into the new year: foundries, IC design, server hardware supply chain, and networking switches.

In summary, the investment opportunity set will be more diversified and selective for the Greater China region in 2024.

1 Under a cross-cyclical approach, the government takes actions sooner and typically takes smaller steps over a longer timeframe or across multiple cycles. 2 14.9% of Mainland China’s population comprises people aged 65 and above. 3 “China issues guidance on humanoid robot development, aiming to establish innovative system by 2025,” Global Times, November 3, 2023. 4 Edge AI is the deployment of AI applications in devices throughout the physical world. It’s called edge AI because the AI computation is done near the user at the edge of the network, close to where the data is located, rather than centrally in a cloud computing facility or private data center. Nvidia, February 17, 2022.  5 HSBC Qianhai, September 7, 2023. 6 HSBC, November 2023. 7 14.9% of mainland China’s population comprises people aged 65 and above.