Tapping into the biggest risk/reward market of 2023
This article first appeared on portfolio-adviser.com on 22nd December 2022 If you had asked me two...
22 January 2023 marks the start of the Chinese New Year. Millions of people around the world are set to celebrate the event, which signals the end of the winter period and is a sign of new growth to come.
Chinese equity investors will certainly be hopping (typo intended) that the new year of the Rabbit will result in more stock market growth than that of the 2022 Tiger, which was less than a roaring success.
The Gregorian calendar year 2022 was a tough one for global stock markets and the Chinese stock market was no exception. Twice in the course of the 12-month period, it fell between 20-30% before recovering slightly to end the year 12% down*.
The year of the Tiger, which began four weeks later on 1 February 2022, has been slightly kinder, mainly thanks to a rally in the first two weeks of January 2023. Over this slightly different 12-month period, the MSCI China is down just over 1%**.
Dale Nicholls, manager of Fidelity China Special Situations PLC says that Chinese economic growth was weighed down by property sector woes and repeated lockdowns as a result of the country’s zero-Covid policy. “Market sentiment towards China has been very negative following the recently concluded Party Congress, and we have seen a number of foreign investors reduce their exposure,” he said.
“In our view, this sell-off has been overdone. We believe that government policy will move to address factors related to zero-Covid and the property sector, along with further easing for both the monetary and fiscal side. This stands in contrast to the trends we see in many developed markets. Similarly, valuations have moved to significant discounts versus both history and other markets.”
With opinion split on the outlook for China today, we give three reasons why you might consider investing and three reasons to be cautious.
Not only has the Chinese government majorly shifted its zero-COVID policy, but it has also reopened the economy at a much faster rate than many political and economic commentators expected. It is also rolling back restrictions on heavy borrowing in the property sector, which has been battered in the last year due, in part, to risky lending that fuelled a wave of defaults. The government has also relaxed its policy of aggressive regulation aimed at reining in the influence of large tech conglomerates. These factors are all positive and will help fuel economic growth.
President Xi Jinping has notably scaled down on aggressive rhetoric towards Taiwan recently. There is the potential for a more pro-China party to come into power in Taiwan in its 2024 elections, so, China upsetting its neighbours, at least immediately, is seeming like less of a concern. The US-China hostilities have also lessened in recent weeks and with face-to-face meetings between US President Biden and Xi and a very public handshake. That said, some of the damage has already been done with some manufacturing capabilities having been shifted away from China to more friendly nations: ‘friend-shoring’ is replacing offshoring.
It’s no secret that China, on a company valuation perspective is screamingly cheap, especially when you consider it’s the second largest economy in the world, with relatively low inflation and GDP expected to grow around 5% in 2023. The A-Share market also offers plenty of opportunities. One way to play China and mitigate against some of the obvious risks is to focus on domestic companies that have impressive ESG credentials. This way you are tapping into their growth potential and stripping out some of the risks associated with the unpredictability in policy making.
Xi Jinping’s willingness to sacrifice economic prosperity for ideological motivations became abundantly clear during Covid when he refused to use more effective Western-made vaccines in favour of less effective domestically manufactured ones.
His zero-COVID policy was arguably ideologically driven as well at the great sacrifice of the economy. COVID Health codes systems heavily restricted movement and were used as a tool of mass surveillance and control. It would be hard to completely discount the possibility of a Putin-like invasion of Taiwan that clearly serves imperialistic / ideological goals, despite likely leading to mass sanctions and the crippling of the economy.
In October of last year, the former Chinese leader Hu was very publicly physically removed from his seat and led out of the room at the 20th party congress. This in way symbolised the final deck-clearing in Xi’s power consolidation. Xi has systematically removed opposition to his rule leaving him surrounded by ‘yes men’.
This type of set-up can lead to brash and unpredictable decision making. From an investment standpoint the lack of predictability and certainty in both policy and decision making is discouraging.
The Chinese population likely started to shrink in 2022 for the first time in decades, and India is now set to become the largest country in 2023. China has a serious ageing population problem that is a consequence of the ‘One-child policy’ of the 1980s. As the parents of this generation of children born in this period move from being ‘young-old’ to ‘old-old,’ the social care demands for them will accelerate as they become more susceptible to illness. This will, in turn, put more strain on the government which is already struggling to meeting the rising cost of healthcare.
This is one of the best performing Chinese equity funds over the past 12 months. The manager aims to identify companies with a competitive advantage and sustainable leadership and specifically targets those he feels are undervalued by about 25-30%. He will then hold them with the expectation they will reach fair value over a three to five-year time horizon.
This investment trust invests in ’Greater China’ companies which are quoted on the stock exchanges of Hong Kong, China, and Taiwan. The managers are growth-oriented investors who target higher quality companies within their ‘best ideas’ approach to the region. The trust is currently trading on a discount of around 4.5%***.
If you don’t want to invest in China, but like the rest of the Asian region, this fund could be an option. The manager has zero direct exposure to the region and has said he is unlikely to change this position until Xi Jinping is no longer in power.
You can find out more about his views in this video interview he recorded with us recently:
*Source: FE fundinfo, total returns in sterling for the MSCI China index, 31 December 2021 to 30 December 2022
**Source: FE fundinfo, total returns in sterling for the MSCI China index, 1 February 2022 to 11 January 2023
***Source: AIC, 11 January 2022
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