China’s equity markets have had a rough start to the year.
Since February, investors rotated out of consumption names that are poised to benefit from the nationwide unwinding of Covid restrictions – that is despite the initial optimism fuelled by the reopening.
We think the selling is overdone and presents an opportunity. Barring any unforeseen circumstances, domestic consumption recovery will be the main pillar of economic growth in China this year and many of these beaten down names are expected to recover as a result.
One thing that is currently front and centre on our clients’ minds is Covid. Six months after doing away with its controversial zero-Covid policy, China is bracing for a new wave of infections that is expected to peak around end-June. Clients are asking if this new outbreak will roll back any progress made on the economic recovery momentum. The short answer is: Very unlikely.
Looking back at the last wave of infections in January, as the virus tore through large swathes of the country, it was still business-as-usual for China. Shops remained open, social restrictions were a thing of the past, and many people went out and about, unafraid of re-infection. Most of the population is now vaccinated and a sizeable percentage has had Covid – some of them more than once. The media is further reporting that vaccines for the new XBB omicron subvariants are on the way. Anecdotal evidence gathered by our team on the ground also suggests this wave, in all likelihood, will be less severe than the last one. Chances of China reverting to another zero-Covid-type lockdown is unlikely.
Going back to the Chinese market’s year-to-date underperformance, we see two main reasons why this has been the case.
First, the market has been chasing short-term trends. Driven by a lack of government stimulus and uneven economic recovery, investors have been running after hot themes such as those related to ChatGPT, wider artificial intelligence and state-owned enterprise reforms, and in the process rotating out of previous winners that were initially lifted by the reopening momentum.
These short-term themes are not sustainable for several reasons. Valuations of AI-related plays, for example, are excessive, and many of these are still conceptual names and their path to profit is still several years out. This brings me back to what had happened in 2015. The market was focused on anything and everything that could have been labelled as ‘internet’-based. Eventually, that excitement unwound and we are already seeing signs of that happening again – sentiment towards AI dipped in April.
Speaking of central state owned enterprises (SOE), reform expectations are leading to a re-rating of these state-owned names, including some that are currently sanctioned by the US. We have reservations on the quality of business models these companies have and believe that reforms will take time and are not without significant challenges.
Before long, the market will inevitably turn its focus back to company fundamentals.
Consumption recovery is coming, 2H will be the turning point
The second reason for the sell-off has been the exceptionally high expectations for a domestic consumption turnaround in the market – and the momentum has thus far fallen short.
Investors were expecting a sharp “V-shaped” recovery, but the reality on the ground has been slightly different. While economic data points were initially strong due to a pent-up demand from late last year, the pace slowed in April. Guidance from companies at their annual results briefing during this period was also conservative. This has led to a retreat in consumer share prices. It is important to note, however, that unlike developed markets, the Chinese government has not relied on handouts to spur consumption demand. Hence, it is not reasonable to draw parallels with Developed Markets on China’s re-opening strength.
So, is it all doom and gloom in China? Not at all.
As I said earlier, we still expect domestic consumption recovery to be the main pillar of economic growth in China this year. This will happen gradually in the second half of 2023 when consumers have better visibility for their income growth and bonus for next year. Moreover, household savings are high to support this spending trend once confidence is restored. Furthermore, the current low-valuation environment is ripe for picking high-quality assets at attractive prices.
Five reasons to invest in China
Our investment approach centres around finding the highest quality companies around five themes that are aligned with China’s long-term growth potential.
First is Aspiration, where rising wealth and a growing aspirational middle class will drive demand for premium goods and services over the coming decades. Next is Digital, where increasing connectivity amid the widespread adoption of technology means a bright future for plays on cybersecurity, the cloud, ‘software as a service’ and smart homes.
Another theme is Green - policymakers globally are committing to a greener and lower carbon world, and China is in the driver’s seat. Developments in renewable energy, batteries, electric vehicles, and related infrastructure offer great potential. Grid parity, when renewable energy is the same as existing power from the grid, could be game-changing. Moreover, Health - fast-increasing disposable incomes are driving demand for healthcare products and services. The opportunity set is diverse, from hospitals and medical equipment providers to research firms and drug & supplement producers. We also favour Wealth - growing prosperity means structural growth for consumer finance, investment services and insurance.
Finally, it is worth mentioning that despite not deploying any major stimulus so far this year, China’s fiscal and monetary policy environment remains accommodative. In April, the Chinese government acknowledged the need to sustain the country’s economic recovery. Liquidity in the system also remains very strong, which is conducive for a rapid market rebound.
Risk factors you should consider prior to investing:
- The value of investments, and the income from them, can go down as well as up and investors may get back less than the amount invested.
- Past performance is not a guide to future results.
- Investment in the Company may not be appropriate for investors who plan to withdraw their money within 5 years.
- The Company may borrow to finance further investment (gearing). The use of gearing is likely to lead to volatility in the Net Asset Value (NAV) meaning that any movement in the value of the company’s assets will result in a magnified movement in the NAV.
- Emerging markets or less developed countries may face more political, economic or structural challenges than developed countries. This may mean your money is at greater risk.
- The Company invests in emerging markets which tend to be more volatile than mature markets and the value of your investment could move sharply up or down.
- As with all stock exchange investments the value of the Company’s shares purchased will immediately fall by the difference between the buying and selling prices, the bid-offer spread. If trading volumes fall, the bid-offer spread can widen.
- There is no guarantee that the market price of the Company’s shares will fully reflect their underlying Net Asset Value.
- Yields are estimated figures and may fluctuate, there are no guarantees that future dividends will match or exceed historic dividends and certain investors may be subject to further tax on dividends.
- The Company may accumulate investment positions which represent more than normal trading volumes which may make it difficult to realise investments and may lead to volatility in the market price of the Company’s shares.
- Movements in exchange rates will impact on both the level of income received and the capital value of your investment.
- The Company invests into other funds which themselves invest in assets such as bonds, company shares, cash and currencies. The objectives and risk profiles of these underlying funds may not be fully in line with those of this Company
Other important information:
Issued by abrdn Fund Managers Limited, registered in England and Wales (740118) at 280 Bishopsgate, London EC2M 4AG. abrdn Investments Limited, registered in Scotland (No. 108419), 10 Queen’s Terrace, Aberdeen AB10 1XL. Both companies are authorised and regulated by the Financial Conduct Authority in the UK.