Don't count China equities out just yet

Q: Market returns to fundamentals and is less generous to unprofitable companies

In a bull market, a lot of companies can exist, simply because there’s so much liquidity. But in the current environment, unprofitable companies have seen significant declines, with corrections of up to 70%. A lot of excess was cleaned out by the correction, and the market overall is now healthier. Valuations are much cheaper, and the remaining companies should be on more solid ground.

Q: Chinese equities are trading at attractive valuations

Compared to the past, Chinese equities are trading at the bottom of their historical trading range. We believe much of the negative sentiment is already reflected in the stock price. The dividend yields of companies trading in Hong Kong appear to be very attractive, especially compared with fixed income. Some Chinese companies have a dividend yield of 8% while still achieving some growth.

China Equities: 1H22 review and 2022 outlook

Investment Outlook 28 Jun 2022 59 min watch

Bin Shi

Head of China Equities

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Key insights

Economic and regulatory conditions have started to improve in China. New COVID cases have come down as the impact to the economy diminishes. Partly owing to the resilient spirit of the Chinese people and companies, China’s exports have mostly stayed the course amid lockdowns and logistics disruption. We expect further normalization in the supply chain and export activity.
There seems to be more clarity in the regulatory environment in recent months as we continue to closely monitor policy risk. With economic stability as a key target in the short and long run, we could see more stimulus to support growth.
Global investor sentiment has stabilized and could improve further. We think it has reached the inflexion point of recovery from pessimism as market returns to fundamentals.
We have increased the number of stocks in our portfolios seeking to mitigate macro risks as we continue to focus on high quality, industry leading companies and look for potential long-term winners among the oversold.

China equities had a tough start to 2022 and underperformed other emerging markets with regulatory headwinds continuing to weigh heavily on the market. But as the first half of the year wore on, we saw more favorable sentiment with global investors returning in earnest in May. In this webinar, our Head of China Equities Bin Shi discussed how we are well positioned for the rest of the year and the future.

China Equities: 1H22 review and 2022 outlook

Economic and regulatory conditions have started to improve in China

Chinese equities have rebounded from their bottom, which was mainly caused by the lockdown policies in Shanghai.
We believe we have seen the inflection point in terms of economic and COVID policies.
Overall, things appear to be on their way back to normalization, which has driven the recent rebound of Chinese equities.
Chinese equities have been beaten down to what we believe is an unsustainably cheap valuation, and if conditions continue to improve, we could be set up for a rebound.

Impact of China’s zero-COVID policy is lessening

Confirmed COVID cases and cities under lockdown peaked in April and have been declining steadily since then.
While COVID policy overall is still very strict, particularly compared with other countries, cases are dropping, the economy is on its way back to normal, and everyday life is back to normal to a large extent.
Although Shanghai was locked down for almost two months, the city’s population is at 25 million versus the 1.4 billion people in China as a whole, and one city’s difficulties are not representative of the country’s difficulties.
Shanghai was an exception, not the norm in China. Beijing was only under lockdown for a couple of weeks, then life was back to normal.

China’s exports stayed resilient amid COVID lockdown and logistics disruption

Investors have to give credit to Chinese workers, entrepreneurs and companies for their resilience. After a brief drop in April, things are very much back to normal.
Exports continue to surprise on the upside. Chinese share of the global export market continues to go up.
One or two months of disruption does not appear to have changed the competitive position of Chinese companies or industries.
Many industries are witnessing continued strong demand, particularly renewable energy, such as solar and electric vehicles.
Tesla’s Shanghai factory is responsible for half of the company’s global production, which is expected to reach 20 million units in three years’ time.
We believe China will continue to be an important manufacturing base.

We have likely passed the peak intensity of regulation impact

Policy wise, we have seen some easing. Chinese official media, which is a representation of the Chinese government’s attitude toward the different sectors, has started to talk positively about the benefits of the Internet platform companies.
While some of the policies of the past were too harsh, we’re now seeing some reversal of those policies, as well as the conclusion of the Internet data regulations.
Even though the government has not made an official announcement, and even though the platform companies are still not allowed to register new users, we think it’s just a matter of time.
The government is concerned about the negative impact of various policies and regulations. It is softening its tone with the Internet platform companies and the property sectors.
Last year, regulations made it difficult for people to get mortgage loans from banks. This year, it’s just the opposite. China has cut mortgage rates several times to encourage people to take out mortgage loans.
So far, the uptake has been underwhelming. It takes time for people to regain their confidence in the property market.
If the government’s attempts to stabilize the economy don’t work and there isn’t a big pickup in property sales, we believe the government will create new measures to stimulate demand.

China sticks to its growth target for 2022

Even with the slowdown caused by COVID lockdowns, China has not changed its growth target for this year.
This means that in the second half of the year, we might see a very different set of measures from the first half, and certainly different from last year.
Government officials have indicated that they are looking at more front-loaded stimulus measures. We believe we can expect to see more supportive measures going forward.

Slowing global growth, rising rates and higher inflation might impact China

China is not immune from global slowdowns caused by high interest rates. But it’s important to point out that Chinese equities did not do well when global growth was robust.
The US slowdown, caused by high rates and inflation, is likely to have an impact on China, particularly on exports.
The export sector has carried the Chinese economy for the past two to three years, and continues to be a strong driver of the Chinese economy.
But at this point, domestic policies are even more important to the GDP growth rate and to the overall market in China. Domestic factors will likely continue to be the dominant drivers of the economy and of the market.
We believe that stronger support policies should be able to offset the weakness caused by external factors.

We don’t expect consumption to pick up significantly

While lockdowns have eased, some damage remains. Many people lost their jobs and lost their savings. In addition, the slowdown caused a lot of anxiety on the part of consumers.
People are less willing to spend, until they feel secured about the future. Hopefully this will improve as policies normalize and the economy stabilizes.
Overall, savings in China continue to run at a high level. While working class people’s balance sheets might be impacted by slowdown and COVID, a lot of people still have strong spending power.
Rather than waiting for consumption to pick up, we are looking for structural opportunities within the consumer space. We’re trying to identify opportunities associated with structural changes instead of betting on the entire sector.

Investor sentiment toward China is stabilizing

Investor sentiment tends to coincide with government policies. The level of pessimism reached a peak in April, after the Shanghai lockdown. But it should not remain negative and is starting to look up.
One month is one-twelfth of a year. We still have time to recover what has been lost in investment and economic growth.
We have seen stabilization in terms of investor sentiment, and surprisingly, we have seen inflows into Chinese equities year to date.
For investors who are focused on the long term, this might be a good time to start tiptoeing into Chinese equities.

Market returns to fundamentals and is less generous to unprofitable companies

Chinese equities are trading at attractive valuations

Historically, a period of market weakness tends to be followed by a strong rally

China is still growing, and the recent period of weakness has made many companies much cheaper.
Because of the slowdown, many companies are better positioned for a rebound.
We’ve seen this play out with Alibaba and Tencent – not because they’ve reported blockbuster earnings, but because of strong top-line growth.
The slowdown has forced companies to cut costs. When growth is not as spectacular as before, companies start to pay more attention to cost.
So even though top-line growth was in line with expectations, bottom-line growth for many companies was better than expected.
Stock prices rebounded because earnings growth was better, which shows that sometimes a bad thing can be a good thing in disguise.
After a slowdown, companies may be set up for better performance going forward. They may be healthier and leaner. And if the economy stabilizes, if the growth comes back, they could report very strong earnings.
As long as the Chinese economy continues to grow, we believe we will see strong performance going forward.

Why invest (and stay invested) in China

Market volatility has made many people hesitant or doubtful about investing in China. In the past, when China was doing really well and encouraging companies to continue to grow, that argument was easy to make. Over the last 18 months, there has been some doubt.
Our view is that China, as the second largest economy in the world, will continue to be an important member of the global community.
China continues to open up, and Chinese manufacturing continues to narrow the gap.
Chinese companies and entrepreneurs are extremely resilient.
Despite the COVID lockdowns, despite the slowdown, despite the policies, they are still working hard to produce the most compelling products at the most attractive price points.
Our job is to identify those companies that we believe will become stronger, more competitive and more well-known globally. We think there are still a lot of great Chinese companies that have that chance.
We believe that Chinese equities could outperform US equities because a lot of high quality Chinese companies are trading at extremely attractive valuations.
We are fully invested at this point. Everywhere you look, you see companies selling at a huge discount.
If things normalize, we could expect a strong rebound in stock prices.

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