China: where the politics are too stable?

China’s ruling party hosted its 20th congress in Beijing’s magnificent Great Hall of the People last week. Held every five years, the congress is seen as the most important meeting in the Chinese Communist Party’s (CCP) political cycle.

One of its main purposes is to elect the top leadership, along with making any required amendments to its constitution.

Leader for life?

Under normal circumstances, 69-year-old President Xi Jinping would have been stepping down as leader after 10 years at the helm. Instead, he gave himself a third five-year term, packed his full of government allies, and could potentially become leader for life. Quite a different situation to the UK where we’ve had five prime ministers in as many years…

While the move was widely anticipated, it wasn’t welcomed by markets. The fear is that his vision for China could result in more repression, more state interference in the economy and continued, possibly worsening political tensions abroad.

The release of China’s latest economic data had been delayed until after the congress, but even rosier-than-expected GDP data couldn’t stop the stock market falling 3% and some of the internet giants seeing their stock prices fall more than 10% on the day.

The data showed that export growth had weakened to 5.7% in September, on the back of slowing global demand, while retail sales also fell. Problems in the real estate sector also continued.

So, what do fund managers think?

Economic policy moves

Policies can also be affected by leadership changes, according to Jerry Wu, a fund manager in Polar Capital’s emerging markets & Asia team. “First and foremost, for investors, the critical question is are we going to see a more pro-growth, pro-business and pro-market Politburo?” he said.

Between late October and early December, the new Politburo will decide whether it wants to stimulate demand.

“In the past five years, the priority of economic policy has been de-risking and deleveraging, culminating in the introduction of more thorough regulations in the consumer internet and the implosion of recklessly over-leveraged property developers like Evergrande,” he said.

However, he believes a pro-growth, pro-business shift would usher in a period of more risk-taking and “unleash its animal spirits”, paving the way for strong productivity growth. “Considering the trough valuation and early signs of the end of a negative earnings revision cycle, we are constructive on China equity heading into 2023,” he added.

Positive outlook

As Europe and the US wrestle with recession, Chinese policy is heading elsewhere, according to Salman Ahmed, global head of macro at strategic asset allocation at Fidelity International. “China is continuing to loosen policy where most developed markets tighten, and it has room to go further still,” he said. Nevertheless, several challenges remain this winter and the economic recovery following zero-Covid policy lockdowns has been mixed.”

While activity has improved, recurring lockdowns and a property sector in transition have left a dent in China’s economy. In response, China has ramped up both fiscal and monetary support. “This support should improve the outlook for China as we head into the fourth quarter,” he said. “We also expect Chinese earnings to improve, as companies begin to enjoy a post-Covid recovery and lower commodity prices.”

Indeed, Chinese households have been in savings mode since the start of the pandemic, with family bank account balances up 39% from the beginning of 2020. According to Matthews Asia, those funds could fuel a consumer rebound, and an A-share recovery, as domestic investors hold about 95% of the that market.

What to worry about… and what not

There are a few issues that Andy Rothman, investment strategist at Matthews Asia, is not worried about: the property market, regulatory policy, demographics, and an invasion of Taiwan.

On the property market, he says there is no bubble. “Bubbles are all about leverage, and homeowner leverage is much lower in China than in the U.S. In China the minimum cash down payment for a new flat is 20% of the purchase price. Far from the median cash down payment of 2% ahead of the U.S. housing crisis. With average new home prices up 33% over five years and 80% over 10 years, prices are not signalling the existence of ghost cities.”

When it comes to regulation he says that while Beijing made a lot of mistakes over the last couple of years, they’ve acknowledged this and have promised to be less disruptive. “Why do I believe them? Because entrepreneurial, privately owned companies drive creation of jobs, innovation, and wealth in China,” he said. “The government depends on these companies.

“China’s population is aging, but it’s a long-term issue: China won’t be as old as Japan is today until 2050,” he continued. “Beijing is taking steps to mitigate a declining workforce.

“The military risks [of an invasion of Taiwan] are huge,” said Andy. “Crossing 100 miles of sea would be far more difficult than Putin’s invasion of Ukraine. And the economic impact would be disastrous. China imports over 80% of the semiconductors it consumes, with about one-third—including all of the most sophisticated chips—coming from Taiwan. This supply would be cut off if there were signs that Beijing planned an attack, crippling China’s economy.”

“So, what am I worried about? China’s zero-COVID policy. Zero-COVID worked well prior to the arrival of Omicron. There were almost no deaths in China, and the economy was strong.
But under Omicron, the economic and social cost has been significant. Fear of lockdowns has made families and companies reluctant to spend. Growth has slowed and unemployment has risen, especially among young people. Under zero-COVID, China’s economy is on an unsustainable path.

“I’m confident, however, that the Chinese government will return to a more pragmatic approach, which strikes a better balance between public health and the economy.”

Funds to consider if you want to invest in China…

There is just one Chinese equity fund on the Chelsea Selection: FSSA Greater China Growth. Run by Martin Lau and co-manager Helen Chen from Hong Kong, it has been a firm favourite of the Chelsea research team for a number of years. The managers look for well-managed businesses with good corporate governance across Hong Kong, China, and Taiwan, and have shown that they can consistently produce the goods in any type of market environment.

Other Chelsea Selection funds investing in the wider Asia region, have a significant weighting to Chinese equities. Fidelity Asia Pacific Opportunities and Guinness Asian Equity Income, for example, have 31.6% and 36% respectively in Chinese companies*.

… or if you want to avoid Chinese equities

China won’t be every investor’s cup of tea, but those who still want to invest in Asia still have options. Schroder Asian Income, for example, has just 13.4% allocated to the country*, while Stewart Asia Pacific Leaders Sustainability has even less: just 5.2%**. And back in August this year, Jason Pidcock, manager of the Jupiter Asian Income fund took his holdings to the country down to zero, saying at the time that he is unlikely to invest again while Xi Jinping is in power.

*Source: fund factsheet, 30 September 2022

Published on 24/10/2022