China: Down but not out

Chris Salih 10/08/2023 in Equities, Asia/Emerging Markets

China, which started off 2023 with all the whizz bang of New Year fireworks, has had its powder dampened. Its economy has been hitting the headlines for all the wrong reasons recently. Yet long term investors reckon there’s still a spark to be had.

Things, admittedly, look tricky. First it was news that trade volumes were falling, suggesting China was slowing sharply. Then the stats showing producer and consumer prices in the country are taking a tumble.

Consumer prices fell by 0.3% in July, in the world’s second largest economy, while producer prices dropped by 4.4%. Those of us watching from the UK may not see the problem. After all, in Britain, with record levels of inflation and the Bank of England hiking rates ever higher in a bid to get it under control, we could do with some more damping down of prices.

But what China is now witnessing is the actual cost of goods both in stores and at the factory gate falling. This indicates a significant slowdown in the Chinese economy (which is also beset by high levels of indebtedness).

Little surprise then that the consensus view of China right now is negative. But is this underestimating the resilience of Chinese consumers and entrepreneurs, and the pragmatism of policymakers?

China remains the largest exposure in the Invesco Asian fund*, with a slightly overweight position given the opportunities manager William Lam is finding there. He sees China as a live example of a market where there’s been a recent shift in sentiment based on a simple narrative: the re-opening of its economy post-Covid lockdowns at the end of last year.

The China market rallied almost 60% from October 2022 through to the January 2023 peak, only to subsequently drop 20% by the end June*.

“Playing the recovery did not work for many investors who entered the trade late,” says William.

He admits the economic recovery is turning out to be more sluggish than expected by Chinese standards, and that a conspicuous lack of optimism at the corporate level reflects the mood of the day: geopolitical risk and lack of stimulus.

However, William believes it’s too early for a post-mortem. “Our base case is for a gradual recovery, with some companies, especially Chinese consumer names, back on our radar,” he says. The fund has added value in China since the trough last year.

Ninety One Asia Pacific Franchise manager Charlie Dutton says China is facing challenges of insufficient domestic demand due to lack of consumer confidence but governments are taking relevant incremental actions.

He says: “We have not reached a ‘whatever it takes moment’, but it is clear that the intensity of economic stimulation is increasing. The longer weak economic data persists, the more stimulatory measures we will see.”

The July Politburo meeting of the Chinese government continued, as Charlie points out, the emphasis on reviving consumer confidence and consumption by promoting the growth in the private economy, with a stronger tone than the April meeting.

“We are also seeing more concrete action plans recently to help Chinese companies in relevant areas,” he says.

Government action and incentives are being deployed to boost, for example, use of electronic products and domestic AI tech, support for vehicle and food and beverage purchases, cut regulations for national science and tech projects, and ease lending rules on mortgage loans.

T. Rowe Price Asian Opportunities Equity portfolio manager Jihong Min admits China’s uneven economic recovery has been a market concern.

But he expects greater economic clarity to emerge in the months ahead as the country transitions toward post-pandemic normality and a new regulatory environment.

He also expects mild inflation in China to allow further room for officials to shore up the economy. “While we do not anticipate large-scale stimulus, we think targeted policy support will continue,” he says.

He continues to see earnings beats in some industries and valuations are undemanding, which should help investors refocus on company fundamentals, in his view.

“We think these are good reasons to stay invested in China, where several long-term trends are likely to drive investment opportunities,” he says.

For instance, he thinks structural growth in the electric vehicle market can benefit related Chinese companies that have shown exceptional strengths operating in different parts of the supply chain.

It’s in vogue to be pessimistic about China’s economy. But economic pessimism has dogged the country since at least the 2001 book, The Coming Collapse of China, in which author Gordon G. Chang forecast China’s “economy, and the government, will collapse. We are not far from that time.”

Similarly dire predictions for China’s economy were common during the Global Financial Crisis, the Trump trade war, and the Covid lockdowns. And yet between 2001 and 2022, inflation-adjusted (real) per capita income rose 4.6 times in China, compared to 33% in the U.S. and 22% in the UK.

In the short term, China looks like a hard play. But short term investors always have to hold on for a bumpy ride – investing only smooths over the long term, which is the way to get the best out of the Asian giant.

*Source: Invesco, August 2023

Ninety One Asia Pacific Franchise

Recent equity moves in the region have provided opportunities for the manager to increase exposure to high quality exposure companies benefiting from key, long term structural growth. Focusing on the China opportunity, the manager is particularly interested in self-sufficiency, with domestic replacement remaining one of the strongest prevalent themes across companies such as Glodon, Kingsoft, Mindray, for example. The manager also likes the premiumisation trend, for example in food safety, as well as in platform economies with the offline to online trend continuing, for example with shopping platform Meituan.

T. Rowe Price Asian Opportunities Equity

The manager is monitoring China’s economy, especially consumer sentiment levels amid weakening job prospects. US-China tensions and how they may affect supply chains globally are also on their radar. Meanwhile, the manager believes restrictive US monetary policy and the spillover impact on the global economy continue to warrant caution. According to the manager an active investment approach, focused on investing in high-quality businesses with resilience against uncertainty, can help to manage these risks.

Invesco Asian

South Korea is the fund’s biggest overweight position. Improvements in corporate governance and dividend pay-outs are being underappreciated by the market, according to the manager, which has provided opportunities to own solid companies, with good balance sheets. In Hong Kong and China, the fund has a mix of large internet companies, life insurers, autos and auto parts manufacturers, a wind turbine manufacturer and selected property and consumer-related stocks. The fund continues to have significant exposure to dominant semiconductor companies in Taiwan and Korea.

Research all Elite Rated Asian Equity funds here.


Photo by Emmanuel Appiah on Unsplash

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