Darius McDermott, managing director of FundCalibre takes a view.
It’s almost impossible to make head nor tails of the Chinese economy and whether it offers value to investors today. The past three or so years have been nothing short of abysmal as increased regulatory oversight, a weak post-Covid economic recovery, concerns over a potential reunification with Taiwan, and ongoing wrangling with the US all weigh heavily on the world’s second largest economy. As a result, the MSCI China is now down some 40 per cent since February 2021*.
However, this year has started on a more positive note, with Chinese equities up roughly 13 per cent year-to-date**. The International Monetary Fund (IMF) has forecast GDP growth of 4.6 per cent in China in 2024, second only to India (6.8 per cent) among major economies***. We’ve also seen improved data for household income & consumption, as well as retail sales. However, despite this, consumer confidence remains unmoved at rock bottom lows.
Matthews Asia investment strategist Andy Rothman says the reasons behind the lack of movement on consumer confidence are fourfold, citing Chinese entrepreneurs fears that President Xi Jinping has fallen out of love with private firms; poor execution of policies like common prosperity – leading to entrepreneurs being reluctant to hire and invest; the collapse of the housing market and subsequent fallout; and the economic impact of worsening relations with the US****.
These have all been well-documented, but I wanted to touch on a couple briefly. The first is that President Xi is not stupid and will realise that entrepreneurs have been a big contributor to China, accounting for one third of global economic growth – and that he will not want to punish them unduly for any prolonged period, simply because it will hinder his own growth plans.
The second is the slowdown in the property market – this is perhaps more concerning given it is the primary store of wealth for Chinese households (it accounts for more than half of household net wealth, compared with a little over one-third for US households). China has more than 30 months worth of unsold housing, or around 28 million units^. At the same time, between 12-15 per cent of sold housing units, or between 65 and 80 million units, lie vacant in China^. Fears in this sector put a slowdown on consumption.
Lombard Odier says the recent rally in Chinese equities is actually at odds with underlying fundamentals. CIO Asia John Woods says corporate revenues will be key to sustaining the rally. However, the Chinese economy continues to suffer from deflation, prompting expectations for looser monetary policy^^.
Rothman believes a pragmatic course correction from Xi could revitalise both entrepreneurs and consumers alike. The figures are there for the consumer – since the beginning of 2020, family bank balances have risen 79 per cent, a net increase equal to 9.1 trillion USD, which is much larger than the GDP of Japan in 2022****. If they are waiting for a catalyst to spend, the impact could be stark on the economy when it does happen.
So why now – valuations could be the answer?
History shows that typically catalysts for change are only seen in hindsight – so as long-term investors we have to consider the potential for growth in tandem with valuations. IMF figures for China are still attractive, while Chinese equities are extremely cheap right now, with the MSCI China Index trading at a price-to-book ratio only marginally above 1^^^. Forward price-to-earnings multiples are currently less than 10 times, compared with developed world equities at 18 times^^^.
FSSA All China investment analyst Tianyi Tang says China was the worst-performing major stock market in 2023. However, its corporate earnings are expected to outgrow the developed markets, creating an interesting opportunity to buy quality China stocks at cheap valuations^^^^.
Tianyi says: “China is still an innovation-driven country, home to the largest number of engineers and scientists globally. It’s also a leader in certain technologies such as electric batteries, solar panels, and drones. So there are still ample opportunities for us to identify companies with cutting-edge technologies that could grow over the long term.”
Invesco Global Emerging Markets fund manager William Lam says there is a great contrarian opportunity in being overweight China in the current environment – adding that market weakness in China has also tended to be broad-based and fairly indiscriminate, which has allowed the team to increase the quality of the China portfolio*^. The fund currently has 23 per cent invested in China, with names like Alibaba, Tencent and JD.com among the top holdings**^.
Fidelity China Special Situations trust manager Dale Nicholls says, despite performing effectively in industries with strong growth potential, the stories of exceptional individual companies are often missed because their valuations are dragged down by negative macro headlines and poor sentiment. He says he is finding plenty of opportunities in China’s industrials sector, borne out of innovation and consolidation; as well as many benefitting from the re-orientation of global supply chains and an increasing preference for local suppliers***^.
He says: “Across sectors, companies are sustaining a fast pace of innovation, evident in measures of R&D spend or their share of global patent applications. This is improving their competitive edge and, in areas like robotics for example, domestic players are closing the gap on global peers.Good quality companies with an edge and scale should profit from gaining market share and are providing attractive investment opportunities.”
Nicholls also holds reasonable exposure to the consumer sector (39 per cent**^) as he believes the country will continue to benefit from the move from export and investment led-growth towards higher quality growth, driven by consumption.
Clearly China has been through a difficult period. It is as unloved as its equities are cheap. But it has tremendous firepower at its disposal and the ruling powers will not want the economy to suffer longer term – so changes can happen fast. Those who are wary of going direct may want to consider regional portfolios with fair exposure to the region, such as Schroder Asian Alpha Plus (which has almost half its portfolio sitting in mainland China, Hong Kong and Taiwan**^) or the Guinness Asian Equity Income fund (which has almost 40 per cent in China)*^^.
*Source: FE Analytics, total returns in sterling, 1 February 2021 to 15 May 2024
**Source: FE Analytics, total returns in sterling, 29 December 2023 to 15 May 2024
***Source: International Monetary Fund, Read GPD growth, April 2024
****Source: Matthews Asia, 10 May 2024
^Source: Lazard, Global Emerging Markets Outlook, Q2 2024
^^Source: Lombard Odier, 14 May 2024
^^^Source: Russell Investments, 7 February 2024
^^^^Source: FSSA Investment Managers, 3 May 2024
*^Source: Invesco, 8 April 2024
**^Source: fund factsheet, 31 March 2024
***^Source: Fidelity, 7 February 2024
*^^Source: fund factsheet, 30 April 2024
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.
