July 26, 2022
It’s not difficult to find China bears these days, but they may have overstayed their welcome.
China bears love to reference last year’s regulatory crackdown, the default risks amongst property developers, the handling of the pandemic and the slowing economy as reasons to convince investors of their view. To be fair, all these points are valid and investors, including ourselves, have adjusted our positioning to reflect these negative views in a greater or lesser extent in our portfolios.
Having said that, as sentiment deteriorates and markets derate, a point of maximum bearishness is reach where the derated market starts looking attractive again, and China might have reached that point in April 2022.
Last year, we went underweight China in our emerging-market portfolios for the first time in many years. The China weight in the global portfolio (CI Select Global Equity Fund) dropped to below 2.5% as a percentage of the total portfolio by mid-2021 and ended the year below 1.5%. However, over the last few months, we have added to our China weight, increasing it to around 7% in CI Select Global Equity Fund and 36% in the emerging-market mandates.
Below is a summary of the six most compelling reasons why we have changed our view and why we believe China could be one of the better-performing equity markets into 2023.
Has been slowing since the second quarter of 2021 but is now showing signs of bottoming. With the help of policymakers, the economy is expected to rebound rather sharply during the first half of 2022. President Xi Jinping has recently reemphasized the government’s commitment to achieve growth of around 5.5% in 2022, but we think this might be bit of a stretch. However, the attempt to even reach 4% growth in 2022 – roughly market consensus – should imply a strong recovery in economic activity for the second half of the year.
Government has started rolling out targeted stimulus measures including tax relief for small and medium enterprises, auto purchase tax cuts, increased local government borrowing, selected interest rate cuts, increased special bond issuance, reducing purchase restrictions in select cities and increased infrastructure spending. Given China’s commitment to an approximate 5.5% growth target, a failure of the economy to lift off soon would compel Beijing to provide more stimulus to get growth back on track. It’s important to note that no big bang stimulus such as what we saw in 2009 and 2010 is expected but supportive of growth nonetheless.
Credit cycle has turned positive after the so-called credit impulse – measuring the change in credit over an annual basis – was in negative territory for the majority of 2021.1
Consumer Price Index
Partly because of the slowing economy, producer price increases in China are not making their way through to consumer price increases in the same way as many other countries. A tamed CPI of below 3.0% provides room for the government and central bank to stimulate the economy.
Valuation at 11.2 times 12 month forward earnings2 is quite compelling both in historical and relative terms. Light positioning by global funds to China is another technical reason to support better returns going forward.
Comparison to the rest of the world
China is becoming the antithesis of what investors are experiencing in the rest of the world and investing is all about the relative comparisons between countries, sectors, securities and asset classes.
Rest of the World
Stable to easing (especially mortgage rates)
Tightening & QT
Reducing (after 2-years of Covid-related stimulus)
Economy (stage of cycle)
Early stage (talks about a recovery)
Late stage (talks about a recession)
Economy (near-term direction)
Bottoming (after a deep slowdown)
Slowing (especially in developed markets)
Turning more positive on China is not without its risks and we are keeping a close eye on the following:
Which we think will not change soon, and the emergence of new Omicron subvariants. Subsequent waves could hinder the expected economic recovery, but it seems China’s approach of early, brief and aggressive lockdowns combined with widespread testing are becoming less disruptive to the economy than the experiment earlier this year in Shanghai.
In the property sector with many developers still facing default risks. The recent development of mortgage repayment failures also needs close watching.
Although the government’s call for “maintaining the stability of the capital markets” in April was encouraging. This was widely interpreted as a sign that the often unexpected, disruptive regulatory changes of late 2020 and 2021 will make way for a more balanced and well-communicated approach.
Growth Rate Projections
Government formally abandoning the +5% growth target for 2021 as this will have major implications for how much stimulus the government is willing to provide.
As a team, we make strategic decisions that will benefit our investors, even if it means shifting directions completely. That’s what we did with China. Despite market noise from many China bears, we remained laser focused on the positive developments happening within the country and eventually increased our weighting as a result. Today, we believe our portfolios are well-positioned in the coming months and into 2023.
1 Source: Macquarie.
2 Source: JP Morgan.
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