By Chetan Sehgal, Lead Portfolio Manager of Templeton Emerging Markets Investment Trust (TEMIT).
The upcoming Chinese New Year will celebrate the tenacious Tiger. According to ancient folklore, the Tiger was steadfast in crossing the river during the Chinese Zodiac race and came third out of the 12 animals, behind the Rat and the Ox. When first seeking potential runners, the Jade Emperor debated between the Lion and the Tiger, choosing the Tiger because of the Lion’s poor temper. To test the Tiger, the Emperor asked him to conquer mountain beasts in a fight, upon which he was allowed to race.
It would take a Tiger’s strength, determination and sagaciousness to take China out of the challenges it is facing today.
China’s common prosperity remains a long-term priority and guiding principle for future policies. In 2022, we expect stability to be of paramount consideration as 2021 turned out to be quite chaotic as policy initiatives were rolled out across many sectors which impacted the status quo. While policy uncertainty could persist in the months ahead, we believe that the government has laid out the broad outlines of major regulatory changes, and incremental news could be centred more on implementation details rather than any further resets of policy.
- Towards the end of 2021, China faced the impact of a prolonged buildup of debt in its real estate sector. We expect the government to continue to try to engineer a careful deleveraging of the sector, as the sector remains vitally important to China’s economy. We would still see more developer defaults in the near term, following China Evergrande’s failure to meet its debt obligations. The slowdown in the property sector would require other sectors to rev up their momentum just to maintain overall economic growth, which looks demanding for now; especially since the local government revenues are dependent on sale of land to property developers, apart from bond issuance to continue with infrastructure investments.
- China is at the crossroads in terms of the direction it chooses in terms for preference of private capital which is growth and profit oriented and seeks dominance or a preference for public capital which provides stability. The nature of the internet sector which allows for companies to expand dramatically and dominate has further skewed that debate.
- The ongoing US-China tensions have spilled into the market for Chinese American depositary receipts (ADRs). The United States recently finalized rules to force the delisting of Chinese companies from US stock exchanges if they fail to comply with US audit inspections and other requirements. Although market sentiment toward ADRs weakened immediately after the move, we believe that companies with discounted valuations and strong fundamentals should eventually attract renewed investor interest. Chinese companies can also seek listings in other markets, which could draw trading volumes to their new venues as a result. In fact, many prominent ADRs are already dual listed in Hong Kong.
- China is one of the few countries which has been resolutely pursuing a zero-COVID-19 policy after the initial outbreak. This has further hampered consumption growth and created more uncertainty both for consumption and the economy. While most other countries would have achieved herd immunity post the Omicron wave; China would have hard choices in 2022.
China has achieved global market leadership in many industries including the upcoming renewable energy and electric battery industries. It is still working resolutely in trying to achieve independence in other technology areas such as semi-conductors and even software. Although the country’s zero-COVID-19 policy and recurring lockdowns could hamstring its near-term economic growth, and regulatory changes have also led to a reset in expectations for some of its largest internet companies, stock valuations have adequately reflected this.
As we usher in the Year of the Tiger, we will watch with interest how China pushes ahead in spite of the challenges. Whilst we have taken more steps to contain our exposure to investment risk, rigorous stock selection will be critical. China’s volatility in the past year has emphasized the need for diversification within portfolios, and we see value in in seeking companies that display strong growth, quality and sustainability characteristics.
Although we expect some uncertainty in China in 2022, we encourage investors to embrace the Tiger’s tenacity and remain focused on companies that create long-term value; even though Tigers today are an endangered species, and most are held in captivity.