Navigating China’s path to recovery

China’s equity markets have experienced notable volatility this year, significantly underperforming global peers. Investor sentiment has been dampened by a combination of geopolitical tensions, economic uncertainties and persistent concerns related to the property sector.

The broader macroeconomic picture also remains subdued, with GDP growth falling short of expectations, particularly in the second quarter of 2024. A major contributor to this slowdown has been weak consumer sentiment, reflected in sluggish retail sales growth.

In a bid to stimulate consumer demand, the government has unveiled incentives such as subsidies to upgrade old home appliances, while also reducing interest rates. These initiatives are designed to catalyse demand and reinvigorate domestic consumption, thereby boosting an economic recovery. For business, these measures represent substantial new avenues for growth.

Navigating sectoral shifts

A key feature of recent market dynamics has been the stark divergence in performance, with traditional “old economy” areas - such as energy, utilities and communication services - outpacing the broader market. In contrast, sectors associated with the “new economy,” particularly consumer-related areas and healthcare, have struggled. While this shift poses challenges for investors like us that are focused on the long-term growth drivers in the Chinese economy, it also offers attractive opportunities for investors with a longer-term view.

Industrials, the largest sector weight in Fidelity China Special Situations PLC, offers significant potential, driven by factors such as consolidation and the bifurcation of supply chains. China’s focus on innovation, exemplified by its increasing R&D spending, is also evident here, with companies enhancing their competitiveness through technological advancements and consolidating market share in a fragmented industry landscape.

The auto space is another area that highlights China’s focus on innovation and increasing competitiveness. Exports of Chinese cars has quintupled in just three years, recently surpassing Japan to become the world’s largest car exporter. China’s share in terms of global electric vehicles (EVs) is approaching 60% and continues to grow.

One illustrative example is the inclusion of Tuhu, China’s leading auto maintenance company, in the portfolio. As the largest player in a growing market, Tuhu stands to benefit from the increasing number of vehicles requiring maintenance, underpinned by China’s position as the world’s largest auto market. This investment aligns with our broader strategy of focusing on market leaders in sectors with strong structural growth drivers.

Another significant holding is Ping An Insurance, a company that offers compelling long-term value despite short-term pressures in the insurance market. Its focus on life insurance, a sector with low penetration in China compared to Western markets, positions it well for future growth. The company’s efforts to improve its agency force and its commitment to shareholder returns through dividends underscore its attractiveness at a time when the stock is trading at a significant discount to book value.

A greater focus on shareholder returns

Despite the overall underperformance of the Chinese market, the earnings outlook for many sectors remains stable and, in some cases, robust. Moreover, we are also encouraged by continued focus from companies on improving shareholder returns through dividend pay-outs and buybacks. This trend is particularly prominent in financials, where a number of State-Owned Enterprises have increased dividend ratios, while smaller financials companies have engaged in buybacks or boosted dividends.

Additionally, several technology and internet companies have increased pay-outs or buyback ratios, driving total shareholder return yield (including both dividend and buyback yields) into double digits. For instance, Alibaba Group Holding and Tencent Holdings have been some of the most aggressive in hiking both dividends and buybacks. For many of these companies, we are seeing shares outstanding decline for the first time. 

Staying focused on fundamentals

Looking ahead, despite the near-term challenges we remain cautiously optimistic about the outlook for China’s markets. The macroeconomic backdrop, while under pressure, is expected to stabilise as the government’s stimulus measures begin to take effect. Significantly, the Chinese consumer, despite current weakness, has a strong balance sheet with significant savings. This could translate into increased spending once confidence is restored. This latent demand, combined with the structural trends in sectors like industrials and technology, supports our positive long-term view.

However, global challenges remain. These include ongoing geopolitical tensions, regulatory shifts and the potential for further economic headwinds. Investors must remain vigilant and selective, focusing on companies with strong competitive positions, robust balance sheets and the ability to navigate an increasingly complex operating environment.

While the past few years have undoubtedly been tough for all China-focused portfolios, the current environment presents a unique set of opportunities. By focusing on sectors with strong structural growth drivers and compelling valuations, we believe the trust is well positioned to benefit from an eventual recovery in China’s markets. As always, our focus will remain on delivering long-term value for investors while navigating the complexities of the market with a disciplined and strategic approach.