Are China valuations too attractive to ignore? asks Darius McDermott, managing director, Fund Calibre
Sometimes managers have to cut through all the noise and focus on valuations and the long-term case for a region.
That’s particularly true of China at the moment. The MSCI China index has fallen almost 16 per cent since mid- February, despite global markets rising over the same period. There are reasons for that, not least geopolitical tensions and a tech pullback partially caused by a regulatory crackdown. The big question for us is how much of that uncertainty is now in the price?
In April, the International Monetary Fund projected growth of 8.4 per cent for China in 2021**, well ahead of anything the developed world can offer. We all know China was ‘first in, first out’ when it comes to the pandemic, but it has recovered admirably, with the economy growing more than 18 per cent in the first quarter of 2021***. As Fidelity China Special Situations manager Dale Nicholls points out, the swift return to “normality” in China should mean lower risks relative to many other countries with higher uncertainty as they still struggle to get the virus under control.
China’s masterplan is clear – it is building new cities based around integrated travel systems, 5G networks and cross-country travel. The current high-speed rail network is 23,500 miles of lines crisscrossing the country, China had no high-speed railways at the beginning of the 21st century**** – have a think about that. This shows the future of China is being planned many years in advance, whereas other leading economies are merely trying to patch up their existing systems. This will allow China’s domestic market to take off in the next few years, with the rising ‘middle class’ looking to increase their quality of life with better healthcare, transport, housing and discretionary goods.
I want to reinforce how important a tailwind China has in moving to a consumption-led economy, when that happens, households will start to leverage. As Matthews Asia investment strategist Andy Rothman points out, last year was the ninth consecutive year where the services and consumption part of Chinese GDP was larger than manufacturing and construction. Consumption is now 56 per cent of China’s GDP, still down on the Organisation for Economic Co-operation and Development (OECD) average of 73 per cent^. The kicker is that domestic consumption has also become more important, with export contributions declining. We also have to add the rise of entrepreneurship and private companies into the mix too.
There are challenges, however, most notably China’s fall in popularity. More established economies are becoming increasingly concerned at China’s dominance, especially around the South China Sea, which is becoming a microcosm of aggressive Chinese expansion claims. As such, the country is now at risk of global controls to limit their expansion. The market has been particularly disappointed that President Biden hasn’t made more progress on lifting Trump’s tariffs with China.
Chinese tech has also stuttered. Regulatory threats hang over these behemoths as the action against Alibaba has shown with its $2.8bn fine by the anti-monopoly regulator over abuse of its market position^^.
Debt and demographics are long-term concerns for China which have been well discussed – the latter is incredibly difficult to repair and the Chinese government is starting to show some signs of desperation, such as the recent switch to the three-child policy.
But despite these risks you cannot ignore the clear opportunities. I recently read that in the 10 years through 2019, China averages around one-third of global economic growth, larger than the combined share from the US, Europe and Japan^.
JPM Growth and Income Trust co-portfolio manager Rebecca Jiang says China is moving away from a capital investment intensive growth model to a more capital light, but human capital heavy growth model. This feeds into the four structural themes running through her investment trust – technology, healthcare, automation and consumption – all of which are aided by this move.
Nicholls says consumption is also an important element in his trust. He also sees opportunities in the insurance sector post Covid-19 as people focus more on protection in areas such as health insurance. He also believes there will be opportunities within cyclicals ***.
There’s also the rapid growth in A-Shares – there are over 3,000 listed companies onshore in China, many of which are very liquid. This depth allows managers to pick and choose interesting bottom-up stock ideas – although there are risks attached.
The bottom line is investing in China for the long term looks increasingly tempting at the current prices, you just have to accept the higher degree of political risk. Beyond a vehicle with a pure China focus, investors may want to consider the likes of Matthews Pacific Tiger or the Guinness Asian Equity Income fund, both of which have their largest country exposure to China^^^.
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.
*Source: FE Analytics – total returns in pounds sterling for Investment Association Global and China/Greater China sectors and the MSCI China, figures from 17 February 2021 to 2 June 2021
**Source: IMF World Economic Outlook, April 2021
***Source: Fidelity – Finding China’s future disruptors – figures taken from Reuters
****Source: CNN Travel – May 2021
^Source: Matthews Asia – Why China? A Macro Perspective
^^Source: BBC News
^^^Source: Provider factsheet at 30 April 2021
