Reopening renews investor optimism in China

by | Jan 27, 2023

Shanghai, China

Investors across the globe are beginning to turn their attention back towards China, as the world’s engine of growth finally appears set to exit its strict Covid restrictions, which have hampered growth and weighed heavily on sentiment.

Below, several investors discuss the likelihood of a prolonged rally for Chinese markets, and where opportunities in the vast economy might emerge.

Looking beyond recognised names

Wenli Zheng, portfolio manager of the T. Rowe Price China Evolution Equity strategy

For investors considering where to allocate capital, China stands out. While the Western world contends with rising rates and quantitative tightening, China is moving in a different direction, implementing accommodative monetary and fiscal policies to underpin economic growth. We expect market leadership to broaden, and investors should look beyond the well-known mega-caps to identify future winners.

Themes we are following closely include growth opportunities able to emerge stronger from the downturn – such as online recruitment, shopping mall operators, and hotel chains. Additionally, we also find ample opportunities in businesses with idiosyncratic drivers, which are doing well despite the weak macro environment – including auto parts and industrial companies levered to the energy transition, shipbuilding, and oil field services. With better visibility on Covid-19 and property market outlook in 2023, we expect various domestic-related sectors – like consumer discretionary, business services, and advertising – to accelerate toward the second half of the year.

Reopening to ignite EMs

Charles Walsh, portfolio manager of the Mirabaud – Equities Global Emerging Markets Fund

Emerging market equity investors have not had much to shout about for the past couple of years. This follows on from what has been described by some as a ‘lost decade’ for the asset class relative to US equities.

The significance of China’s reopening is hard to overstate for EM equities. The restrictions during 2022 had a hugely negative impact on supply chains, employment, and sentiment. As activity normalises with the relaxation of restrictions, at the same time as the regulation of property and platform company sectors eases, this should provide significant support for China equities and EM more broadly.

Seeking strategically aligned innovators

Sara Moreno, portfolio manager of the PGIM Jennison Emerging Markets Equity Fund

We believe there are few, if any, equity investors who can claim a fundamental competence – let alone an ‘edge’ – in divining the intentions of the Chinese leaders. More important to successful longer-term positioning in China, in our view, is to seek out companies with great growth potential, whose products and services are aligned with the government’s strategic priorities and keep a watchful eye on the policy environment.

Given China’s dependence on imported fossil fuels, we believe the country’s green energy sectors are particularly attractive, as we expect prolonged secular growth in this sector. In addition, we are focusing on smaller Chinese companies with disruptive technologies less correlated to macroeconomic and policy concerns. These smaller tech companies tend to pursue innovation in line with the Chinese Communist Party’s objectives and face less regulatory scrutiny.

Appealing upside for ADRs

Antoine Denis, head of advisory at Syz Bank

Chinese equities have been down for many reasons, but there are other factors that should be reconsidered that are more positive. The re-election of President Xi Jinping, the easing of the Covid policy, and valuations at depressed levels could restore China’s growth momentum. Ever since the regulatory crackdown started with the cancelation of the Ant Group IPO, Chinese ADRs have been under intense stress, losing about 80% of their value and being perceived as ‘uninvestable’ by major US financial firms.

Overall, most of the decline so far is explained by geopolitical factors rather than by fundamentals, which makes our bottom-up view on some stocks appealing. China ADRs remain very cheap in comparison to US counterparts, and margins are still attractive – even if cut in half.

Household consumption to surge

Niloofar Rafiei, economist at Sarasin & Partners

We are hopeful the remainder of 2023 will be a year of economic recovery for China that could see GDP growth rebound from an expected meagre 3% in 2022 to around 5% in 2023. For this to happen, the drivers of China’s economic growth will need to rotate and the economy to rely less on government infrastructure spending and exports, and focus on a more sustainable and resilient source – household consumption.

Household consumption will accelerate as people spend lockdown savings, and experience-deprived households will shift to services spending. With demand picking up and supply constraints in production easing, it is unclear whether domestic inflationary pressures will mount. Consumer price inflation is currently below 2%, and labour supply is plentiful, with the official urban unemployment rate at about 5.5%, but in reality it is probably substantially higher given reported wage falls of 10-20%.

Brighter prospects for property

Wei Siong Cheong, portfolio manager at Neuberger Berman

Valuations on Chinese equities are attractive, and the asset class should see strong momentum in the first half of the year. In fixed income, we are especially enthusiastic about the prospects of convertible and property sector bonds. Convertible bonds participate in equity upside, with limited downside risks. On the property front, a significant portion of China’s high yield property bond universe is trading at distressed levels. The recent emphasis on improving the balance sheets and financing capability of ‘systemically important’ developers reflects regulators’ intention to support the sector and ‘ringfence’ better names. Homebuyer sentiment will also likely improve.

We believe these factors have not been fully priced in by investors and the sector should provide a source of potential upside in the months ahead. In contrast, we are less optimistic on the outlook for duration. Stronger growth and increased supply pressure should keep rates grinding higher for most of 2023.

Opportunity in social interaction

Sunny Bangia, portfolio manager at Antipodes Partners

Chinese citizens have not had the normal social interactions we are taking for granted here in the west. But as the economy reopens, people will start to interact again. We will see people going to entertainment functions, sporting events, and celebrating holidays. With that, an interesting point will be what happens to businesses exposed to that part of the market, such as Wuliangye, the second largest Baiju white spirits maker in China.

This is a high quality, very strong structural growth business that has seen two years of earnings downgrades as the economy has effectively been in shutdown. When the economy reopens, we think the business will be on a reasonable earnings multiple, about 18x, which is a 15-20% discount to global spirits businesses around the world.

Stable politics remains crucial

Mali Chivakul, emerging markets strategist at J. Safra Sarasin

We project growth to improve from 3.2% in 2022 to 4.4% and 4.2% in 2023-24 as China reopens gradually. While restrictions on movement will be gradually relaxed, they could be ramped up locally if hospital capacity becomes stretched. The ‘reopening’ period will therefore likely take a few months to play out.

China’s reopening will likely not benefit EM exports much, as the pent-up demand is mostly in services, while industrial materials and commodities will be driven by the still sluggish housing investment. A stable political environment is also important as financial markets become even more sensitive to any negative news in this low-liquidity environment.

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