Our investment team review what has been a volatile period for investors in China. From geopolitics to Covid concerns, they discuss what’s been driving this uncertainty and provide an insight into what happens next across both equity and fixed income markets.

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Key points
 

  • Investor sentiment towards China has been impacted over recent months by a combination of regulatory, geopolitical and Covid-related issues. 
  • On the equities side, we have been putting money to work in areas where we see long-term value. Core tech names have sold-off significantly in a correction comparable to that of the DotCom crash in places.
  • Despite near-term uncertainties, it is important to recognise that China’s long-term structural drivers are still in place. Trends like the growth of the middle class and urbanisation provide a long runway for growth.

Macro backdrop

Andrew McCaffery: Some of the significant concerns we held prior to the invasion have been accentuated by the crisis in Ukraine. There is now greater risk that we are heading into a stagflationary environment, with greater risks to growth and further supply chain disruption.

Geopolitical concerns have been raised by the strong sanctions that have been put into place on Russia and the speed at which they were implemented. For China, investors are particularly concerned about geopolitics. China needs to consider how it navigates this situation carefully, as there are other parties around the world that will look to label its actions in certain ways for their own benefit.

President Xi moving to support Putin in a clear and vocal way is being rightly highlighted as a tail risk, but this is highly unlikely in my view. China’s attitudes towards the war are obviously a concern, particularly in context of the economic implications of its actions, but at this stage it is showing willingness to work towards cessation and peace. Nevertheless, we could still see some difficult news headlines emerging.

Covid in China

Andrew McCaffery: Covid is still playing out in China and the economic optimism we were seeing not long ago now looks a bit less positive now, with growth projections being lowered. China’s authorities are pledging support, but the risks around stagflation have increased.

Vanessa Chan: There are two things to consider. Firstly, economic and social stability are key for China. It will tackle Covid how it believes is suitable for itself, not how others approach it. Second, the vaccination rate is now about 80% in China, so the way it handles covid might change as a result. For example, in Shanghai we are seeing small neighbourhood lockdowns for two to three days, rather than large scale lockdowns; this change will allow business and social activity to recover more quickly when covid spikes occur. We did see a seven-day, whole city lockdown in Shenzhen recently, but the government carried out testing to screen out cases and limit the effects on business and productivity, resulting in shorter, lower levels of disruption and reducing the adverse impact on activity. I expect that policy will likely become focused in this manner in future.

US regulator delisting Chinese companies

Andrew McCaffery: The main issue regarding the delisting of American Depositary Receipts (ADRs) is liquidity, as there appeared to be some forced selling at a time when liquidity evaporated. Over time this effect will calm down, particularly as China is committed to improving liquidity in its capital markets in order to allow access to a broader array of investors.

In the longer-term, this situation shows the need to improve US-China relations. That being said, we are definitely seeing some reporting biases. For example, in US and European reporting we have seen stories that emphasise and accentuate the risks associated with the ADR situation. We need to make sure we look through an unbiased lens when doing our analysis.

Dale Nicholls: Most companies listed in the US can move to Hong Kong, with most investors also able to follow. There are liquidity perspectives to consider, but this will improve over time. I was buying over this period, given the opportunities created by some of the sell-offs. I am more focused on the underlying value of companies, than where the listing is. The sell-offs took some stock valuations to extreme levels, presenting attractive opportunities.

More broadly, sentiment has been very weak and this is something that is usually seen at market bottoms. The combination of weak sentiment, low valuations and macroeconomic pressures creates longer-term opportunities and we have put money into areas where we see long-term value. In this regard, it is important to note that some core technology names have sold-off significantly over the past year in a correction comparable to that of the DotCom crash in places.

Consumption remains a key long-term growth driver

Dale Nicholls: For the Chinese government to reach its recently announced growth target, overall activity will need to accelerate. Recent data points have been on the negative side, which means regulators will need to do more to support growth, particularly after the recent Covid lockdowns. We think we will see more stimulus on the monetary side and definitely more on fiscal side in the second half of year.

We are seeing some pockets of strength in consumption, but it is not great at the moment overall. The slowdown we saw at the end of last year due to Covid lockdowns and property has had an effect. How things play out with Covid will be a big factor in how consumption develops in the coming months.

Companies we talk to are seeing some impact on the consumer side. For example, a sportswear company I met with recently was discussing its fortunes pre- and post-lockdown explicitly, so it is having a significant impact. There is clear impact on supply chains as well; the recent lockdowns in Shenzhen will have repercussions, given the huge productive capacity that was affected there, so we will need to brace for some short-term pain. In general, people seem to appreciate the move away from the zero-Covid policy, as this represents a step forward and a move to exit the pandemic.

In the longer-term, positive structural drivers are still in place. Trends like the growth of the middle class and urbanisation provide a long path for growth. There has also been some discussion of household registration reforms, which will help as it could provide economic support to migrant workers who are currently not afforded it to the level of other citizens; this could help increase demand and wages.

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