China: Will the recovery continue to misfire?

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.

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.

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.

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.

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.