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Does China’s Covid bounce back make it a 2021 investment?

16 December 2020

Will China’s V-shaped recovery continue in 2021? Darius McDermott, managing director, FundCalibre, looks at the country’s response to the pandemic, where its growth has occurred since and the potential impact of the US President Elect’s attitude to China.

China, as we know, was the first global economy in lockdown due to Covid-19 and the pain was quickly felt with inflation adjusted retail sales falling by almost a quarter in January and February 2020*.

At the time of writing, we are now entering the final month of the year and China’s fortunes have reversed – driven by technology and the consumer. Year-to-date the MSCI China is up 28%**, with growth estimated at more than 8% for 2021***.

Much has been made of the Chinese government’s strong response to Covid-19 and how it avoided the deadly second wave. According to figures from Matthews Asia, there has not been a Covid death in China since mid-April, and only 374 patients were in hospital as of 15 November, down from 58,016 in February^. Whenever an outbreak occurs, China’s government is quick to respond with massive testing and contact tracing.

This has helped facilitate the V-shaped recovery that has become the envy of every other global economy. Auto-sales have recorded six months of double-digit year-over-year (YoY) growth, and new home sales have risen YoY for the last six months^. This compares to a near 40% fall for the first two months of the year. Even bars and restaurants recorded a small YoY increase in October 2020^.

Within the stock market, it has been the consumer discretionary and communication sectors (which encompass the largest internet companies) driving returns. A note from Lazard points out that when you look at these sectors it is three stocks – Alibaba, Meituan and Tencent – that drove 90% of China’s outperformance in the first nine months of 2020^^.

The consumer is willing to spend, as evidenced by the record-breaking numbers for the two largest shopping days in China each year: the 6.18 Festival in June and, more recently, the Singles Day event in November. The latter saw e-commerce goliaths Alibaba and JD.com record some $115bn in sales across their platforms in total, each hitting an individual record^^^.

The question now is whether this recovery can continue, with pessimists pointing to it being purely technology based. Geopolitical tensions with other nations have been fractious and the US cracked has down on a number of China’s leading tech companies, starting with telecom giant Huawei. Numerous Chinese firms also began pursuing secondary listings in Hong Kong and mainland China to get around strict new audit rules in the United States.

Matthews Asia Investment Strategist Andy Rothman believes that improving relations with China will be one of the Biden administrations’ top priorities – citing a need for change in rhetoric and greater collaboration with the region. Others believe Biden may only take a slightly easier line with China – which would not be as beneficial^.

So where might the opportunities lie? First Sentier Investors says China is targeting a broader-based recovery from the pandemic – citing improved economic data, industrial production, fixed asset investment and retail sales. It believes the recovery will continue as activities return to normal and the government continues to pledge support. In addition to targeting companies “with strong technical and execution capabilities, and those that have benefitted from the changes in consumer behaviour”, the team also feels there a number of undervalued companies that have suffered in the short-term but still have strong franchises^^^^.

Fidelity China Special Situations trust manager Dale Nicholls says online behemoths Tencent and Alibaba will continue to benefit as consumer habits shift, however he also feels the gap between growth and value names has opened up an opportunity. One area he is particularly keen on is the insurance sector, which he feels is underpenetrated with more Chinese people likely to take out policies as they become more affluent. He points to companies like China Life that are trading on single digit multiples with decent long-term growth stories^*.

We also feel the tech story has more legs given the dominant position the leading players have. The recovery has been strong and there is an argument the easy money has been made – but we’ve also seen a significant change in consumer appetite making the chances of long-lasting recovery more realistic, particularly if a vaccine is distributed successfully.

Those who feel the V-shape recovery is set to continue may want to consider the likes of the Invesco China Equity fund or the FSSA Greater China Growth fund, while the Fidelity China Special Situations trust is an alternative in the investment trust space. Those looking for more diversity may like the Matthews Pacific Tiger fund, which has over half its exposure to China and Hong Kong^^*.

*Source – Matthews Asia Sinology – China’s economic resilience

**Source: FE Analytics, total returns in sterling, 31 December 2019 to 26 November 2020

***Source: International Monetary Fund – World Economic Outlook – October 2020

^Source: Matthews Asia Sinology – Biden & China: Building Back Better

^^Source: Lazard – Outlook for Emerging Markets – October 2020

^^^Source: CNBC.com

^^^^Source: FSSA Investment Managers – China Equity – October 2020

^*Source: Fund Update – China Special Situation plc – October 2020

^^*Source: Fund factsheet, 31 October 2020

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius’s views are his own and do not constitute financial advice.

Professional Paraplanner