China: Will the recovery continue to misfire?

Bin Shi explains how his team is positioning for potential positive market catalysts

China 19 Sep 2023 43 min watch

Bin Shi

Head of China Equities

Key insights:

We believe the demise of the Chinese economy has been greatly exaggerated. China is in a different growth stage and economic environment, but it is on a long-term growth trajectory with a lot of potential.
Market sentiment on China is overwhelmingly—we would say unjustifiably—negative, having fallen back to the level of last October when COVID restrictions were the tightest. China equity is a complex and volatile asset class, however, given the already low valuations in the market, there will be a higher chance for a meaningful rebound rather than downside surprises.
Government policy appears to have reached a turning point in recent weeks, starting with the lifting of some homebuying controls across Chinese cities. However, because the government has been slow to act, it will likely take longer and bigger support measures to make an impact on a sputtering economy.
We think the probability of a systemic financial crisis remains low. The targeted policy support to date, coupled with nascent signs that global manufacturing activity may be inflecting positively, may provide sufficient cushion to prevent increasingly negative outcomes for the Chinese economy.
We are hopeful that a clear direction will now be established to support sustainable growth, and continuous policy support will follow. That said, a massive stimulus package is unlikely from our perspective.
Strong competitiveness from Chinese corporations is keeping us optimistic in staying invested for the long term. Not only are they adapting to the various external challenges in this volatile environment, they continue to invest in technology, invest in research and development (R&D), control costs and grow their business. And China is going global. Chinese companies are quick to adapt and successfully competing with well established global brands in international markets, such as those in the electric vehicles and online gaming sectors.
Chinese equity markets still hold significant opportunities for active investing in our view, especially with cheap valuations and more government support to come. We see particular opportunities in health care, consumer and financial services.

China: Will the recovery continue to misfire?

Since China emerged from a long COVID lockdown, its economic recovery has been uneven. It is facing high youth unemployment, a troubled property sector and debt-ridden local governments, and international investors have scrambled for the exit, leaving Chinese equities looking remarkably cheap.

All of that prompts three questions. Is China a value trap? What’s the outlook for policy? And where are the opportunities for active investors?

Expand all panels

Sentiment has soured – but could sweeten suddenly

Over the decades, we’ve seen many large swings in sentiment towards China. These usually go too far, and we think this can be the case today.

China certainly faces considerable challenges. But people have been predicting the collapse of the Chinese economy for years, and they’ve been wrong every time. We think they might be wrong this time too.

And despite all the challenges that China faces, it still has a lot going for it. There’s plenty more upside to come from urbanisation, and the country’s GDP per capita remains low by international standards – meaning that there’s a long way to go before the country hits a ceiling in its GDP growth rate. China still has plenty of potential.

Of course, potential isn’t always realised. The government needs to adopt the right policies to get the right results. But we think the pessimism is overdone. Sentiment is almost back to the levels of October 2022, when China’s zero-COVID policy was at its most stringent. We believe a sustained improvement in data could lead to a rally.

A turning point in policy

In recent weeks, the authorities have lifted some of the homebuying controls imposed in Chinese cities, including the first tier cities – a major development given the importance of China’s property market. This follows cuts to mortgage rates, benchmark interest rates and the banks’ reserve requirement ratios. But these incremental measures will take time to have an impact on the economy.

In the past, the Chinese authorities preferred fiscal policy to monetary policy when it came to stimulating the economy. Now, however, they’re using monetary policy even as the West has resorted to fiscal stimulus. Essentially, both groups of policymakers have recognised the need to combine monetary and fiscal policy to engineer an economic recovery.

No big bazooka?

Some investors are hoping for a blast of fiscal stimulus to get the economy back on track. We don’t think we’re going to see the sort of massive stimulus package we saw in the past. The Chinese authorities appear responsive to data, so we expect them to do more if the economy doesn’t respond as expected. But we think they’ll continue to take an incremental approach.

We should remember, too, that the ‘big bazooka’ can have unintended consequences. It might be very positive for the economy in the short term, but the debt problems China is facing today are a result of the $4 trillion stimulus package of 2008-2009. The leverage ratio of Chinese businesses has been rising ever since, and the current troubles of the property market and local governments partially stem from that. So, as long-term investors, we’d rather see the government act responsibly. In the meantime, we’re focused on uncovering opportunities in an oversold market.

China goes global

So where are the opportunities in China today? Many companies have enjoyed spectacular growth in the domestic market. To keep growing strongly, these companies now need to look abroad.

They are already doing so. Chinese companies are thriving internationally in areas such as online gaming and ecommerce. And because these firms have survived fierce domestic competition, they’re well placed to succeed in the international market. This is a major theme for some of our investments because Chinese companies are just starting to go global.

In many cases, their success is already striking. Automobiles are not traditionally China’s strong suit, but China is now the largest car exporter in the world. In the long run, we expect to see many more Chinese cars on other countries’ streets.

We also expect Chinese companies to continue to advance in their technology, sophistication and understanding of the international market. And as long as they’re quick to adapt and learn, they should be able to compete very successfully abroad.

Brighter prospects

These bright international prospects support our view that investors’ current pessimism towards China is misplaced. China is on a long-term growth trajectory with a lot of potential, and we do not see a V-shape recovery. With cheap valuations and increasingly innovative companies, we see no shortage of attractions in China’s equity markets – especially given the prospect of further policy support. We see particular opportunities in health care, consumer and financial services.