Sunday 22 January is the Chinese New Year which, according to the China’s lunar calendar, marks the start of the Year of the Rabbit. In Chinese culture, rabbits’ quiet personalities are seen to mask their confidence and strength. People born in the year of the rabbit – which occurs every 12 years – are considered to be vigilant and quick minded.
“These are qualities that could prove valuable at a time when data released this week has confirmed that in 2022 China experienced 3% GDP growth, the second lowest level of annual growth since the 1970s and down from 8.1% in 2021,” said Jason Hollands, Managing Director with online investment platform Bestinvest.
However, China is undergoing a significant shift in direction. After two years of enforcing an ultra-draconian and economically disruptive ‘Zero COVID’ strategy of strict lockdowns, which prompted the biggest mass demonstrations since the Tiananmen Square protests in 1989, Chinese authorities began abruptly lifting restrictions on 7 December.
The reopening of the Chinese economy and easing of restrictions have occurred at a faster pace than many expected, which has front-loaded the spread of COVID. According to a team from the National School of Development at Beijing University, the nationwide COVID infection ratio was estimated to have reached 64% as of 11 January (and so could be over 70% by now).
“If infection rates are as high as estimated, this suggests that the virus has already peaked, and that the economy should begin recovering from the second quarter,” said Hollands. “Q4 2022 GDP data, released yesterday, which only covered the very early days of the easing of restrictions, came in ahead if expectations.”
Renewed optimism
The exit from Zero COVID has led to renewed optimism about the prospects for China, which has been deeply out of favour with investors for the last couple of years. Hollands points to a recent Reuters poll of economists which revealed that the average estimate of Chinese GDP growth in 2023 was 4.9%, well ahead of the World Bank’s global forecast of 1.7% for the year.
“Investors are starting to take note after shunning China for two years,” he said. “While global equity markets took a downward turn in early 2022 as the inflationary surge gathered pace, Chinese equities peaked – and rapidly tumbled – a year earlier, dogged by concerns over the fragility of its property sector, crackdowns on tech companies and the educational sector, and the increasingly authoritarian shift under President Xi.”
As the chart below shows, since peaking in mid-February 2021, the MSCI China Index had halved in value by December last year.
However, since the lifting of COVID restrictions on 7 December the MSCI China Index has rebounded c.16% while the NASDAQ Gold Dragon Index of US-listed Chinese companies has surged c.20%. Despite their rebound, Chinese equity valuations continue to trade at a discount compared to broader global equities.
So, is China now investible, or have investors missed the boat?
Hollands says: “The outlook is certainly more positive than it has been for some time, but there are caveats too. Concerns about human rights, the deterioration in China’s relationship with the US and its sabre-rattling over Taiwan have not gone away.”
And the longer-term case for China also faces a major headwind with the population starting to shrink, a result of its disastrous former ‘One Child’ policy. This year India, China’s main rival for the emerging market crown, is set to eclipse China as the world’s most populated nation. “In my view India is a more compelling long-term structural growth story than China,” Hollands says.
Hollands also points out that, alongside the end of Zero COVID, there are other signs that the Chinese regime is prioritising growth and that regulatory crackdowns are over (for now): “Unlike much of the world where borrowing costs continue to rise, monetary policy in China remains relative loose with the potential for a further cut in borrowing costs this year.”
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On the back of the experience of the last few years, which exposed the vulnerabilities of global supply chains, many international businesses are increasingly focused on both onshoring production closer to home, as well as diversifying their supply chains so they are less exposed to China. However, notwithstanding the greater emphasis on supply chain security, most businesses cannot rapidly extricate themselves from China and it is a dominant producer in certain sectors, notably solar infrastructure.
In the near term, growth in Chinese exports is likely to be tempered by expected recessions in the developed world. The greater opportunity over the coming couple of years is the prospect for a recovery in domestic consumption.
JP Morgan estimates that over the last few years of harsh restrictions, the Chinese population have accumulated 5.7 trillion Yuan (£690 billion) of excess savings, much of which could come pouring back into goods and services.
“A rebound in the Chinese economy would have a positive impact on global growth, potentially facilitating a softer landing for the global economy than might otherwise be the case given the impact of inflation and rising borrowing costs,” said Hollands.
From an investment perspective, improving prospects for China are also good news for wider Asian and emerging markets. China is a voracious importer of raw materials, so increased demand would benefit emerging market producers. And a further tailwind to support the case for these markets would be a continued weakening of the US dollar (which had rallied hard up until last autumn) as this lowers the cost of servicing dollar-debt, reduces the cost of commodities (which are priced in dollars) and eases financial conditions.
Tactics to gain China exposure
For risk management reasons, Hollands argues that most retail investors should look to get their exposure to China via broader Asian or global emerging market funds. Chinese companies are, after all, 36% of the MSCI Asia ex Japan and 32% of the MSCI Emerging Market indices, widely used benchmarks for such funds.
Bestinvest’s key picks include the Aubrey Global Emerging Market Opportunities fund, which focuses on the rise of emerging market consumption, and the Fidelity Asian Values investment trust which has 29% invested in Chinese stocks. For those willing to take the greater risk that comes with a specialist China fund, the Fidelity China Special Situations investment trust is worth considering.
