By Jian Shi Cortesi, Investment Director, Asian and Chinese Equities, GAM Investments
MSCI China Index saw lacklustre performance year to date. Volatility picked up recently after the rally in the spring and early summer. A higher equity risk premium indicates more risk factored in, correlating with lower valuations. Currently, the implied equity risk premium in China is comparable to levels seen during the global financial crisis, suggesting the market has accounted for considerable risk already.
Despite enduring a bearish trend for approximately three years, we believe the potential for further decline for China is relatively limited. The market is ripe with latent upside potential; however, the realisation of this potential hinges on the emergence of a catalyst to propel the market upwards. The anticipation is for a trigger that will unlock the inherent value and drive a positive shift in the market trajectory. The market is already simmering, but needs continuous addition of fuel to reach a full boil.
Property market stabilisation
The shadow cast by the Evergrande default has lingered for several years, creating an overhang that continues to affect investor sentiment. Despite the minimal exposure of many Chinese companies to the real estate market, the sector’s troubles have broadly impacted perceptions of Chinese equities.
It is important to differentiate the current situation from the 2008 US financial crisis. The Chinese banking system has shown resilience, with the challenges primarily concentrated among developers rather than stemming from mortgage defaults. The defaulted loans represent a minor portion of the banks’ total loan portfolios and are generally secured by significant collateral, providing a safeguard for the financial institutions.
While the property market may not be heading towards a crisis similar to the 2008 meltdown, it is evident that transactions and construction levels are expected to be lower, potentially impacting GDP growth. The government’s strategic actions have collectively contributed to the stabilisation efforts. These steps have been incremental, reflecting a cautious yet proactive approach to managing the property market’s health and ensuring the stability of the broader financial system.
Transition in the composition of China’s GDP growth
We discern a multifaceted shift in China’s GDP growth for 2024. Digitalisation emerges as a pivotal force, anticipated to bolster GDP by an estimated 3.3%. The pivot to eco-friendly energy sources, encompassing solar, wind and electric vehicles, is forecasted to yield an additional 1.7%. Meanwhile, consumer spending, notably in the realms of travel and dining, is expected to contribute 0.4%, with other sectors collectively adding another 0.7%. In stark contrast, the real estate domain and its associated industries are currently exerting a 1.4% drag on GDP growth.2
BYD is revolutionising the EV space
BYD stands out as a revolutionary force in the electric vehicle (EV) industry, not only within China but also on a global scale. As the world’s largest EV seller by volume4, BYD offers a diverse range of vehicles, from basic models starting at USD 9,000 to premium options priced at USD 300,000.5 Its product lineup includes both pure electric and hybrid cars, providing consumers with the flexibility to choose according to their preferences.
What sets BYD apart is its commitment to continuous improvement in vehicle quality and performance while simultaneously reducing costs. This year it introduced an innovative hybrid car which can travel up to 2,000 kilometres on a single tank of petrol, equivalent to the distance from New York to Miami, with a starting price of just USD 14,000. This pricing strategy positions BYD’s hybrid and pure electric cars as more affordable alternatives to traditional fuel-powered vehicles, which is likely to further drive EV adoption in the Chinese market.
BYD’s remarkable 43% increase in sales volume in China last year, at the expense of major competitors like Volkswagen, Toyota, Honda and Changan, underscores the shifting dynamics in the automotive industry. The rise of local brands with technological advantages in EVs is reshaping market shares, particularly in the crucial Chinese car market, which accounts for a third of global car sales annually.7 BYD’s scale in China not only solidifies its domestic market share but also provides a springboard for international expansion. The company’s scale advantage facilitates its entry into export markets. The newly proposed EU tariffs on Chinese EVs are not enough to take away the cost advantage of BYD cars in Europe. Nevertheless, we don’t expect Europe to be a major revenue contributor to BYD. BYD’s major export opportunities are in regions without strong domestic car brands, such as Australia, Israel, Russia, the Middle East, Latin America and Southeast Asia.
The simmering transformation
BYD’s trajectory in the EV industry is a testament to China’s broader policy goals. As common wisdom advises ‘don’t fight the Fed’, a similar approach should be taken with Chinese policies. The government’s broader policy is steering away from an overreliance on real estate, a sector that is not viable for indefinite growth, and is instead directing efforts towards the development of clean energy and digitalisation. There is a substantial domestic drive for technological innovation, particularly in digitalisation, artificial intelligence and autonomous driving, all of which are strongly supported by the government.
Although it is difficult to predict an exact timeline for the transformation underway in China, we believe it is building a foundation for future economic growth, and the impact will manifest in the coming years.
