China’s fireworks fizzle out

When it finally put an end to its zero-Covid policy and reopened its doors to the world, many investors expected both the Chinese economy and its stock market to rebound quickly. And, having started 2023 with a bang, it seemed they were right.

But the fireworks have since fizzled out and the economy is slowing once again. Sentiment has turned negative, and investors are getting cold feet.

So what next for the world’s second largest economy and the powerhouse of Asia?

What has happened?

China introduced the world’s strictest measures to help contain the coronavirus and maintained them while the rest of the world returned to normal. Its zero-Covid policy was finally abandoned at the end of 2022, with the decision being taken to swiftly lift restrictions, rather than phasing them out gradually. But optimism has been tempered by weaker-than-expected data in retail sales, industrial output, and investments. Unfortunately, it’s not clear whether or not this is just a short-term blip.

Top trends to watch

While there’s disappointment that consumers aren’t spending as expected, Kunjal Gala, manager of the Federated Hermes Global Emerging Markets SMID Equity fund, is looking more long-term.

In a presentation on themes shaping emerging markets, he emphasised his optimism for the future and pointed out that China was undergoing a significant transformation. “In a number of areas – such as automation, renewables and electric vehicles – Chinese companies are making a difference, not just domestically but globally,” he said.

Pessimism is popular

The consensus view of the Chinese economy may be too negative, according to Andy Rothman, Investment Strategist at Matthews Asia. Chinese consumers are estimated to account for 20% of global luxury sales, he pointed out, while in 2021 they installed more industrial robots than the rest of the world combined.

“The resilience of Chinese consumers and entrepreneurs, as well as the pragmatism of the country’s policymakers, have often been underestimated, and that is likely the case again today,” he added.

No quick fixes

Louise Loo, lead economist at Oxford Economics, believes China is now on a lower, but potentially healthier, growth regime, albeit with no policy quick fixes for its economic challenges. “We think authorities will introduce more prudent variants of policy easing as they buy time to resolve the bigger structural issues of property-sector overcapacity, rising debt risks, and challenges posed by ageing demographics,” she said.

She also highlighted the potential for new and green energy, high-tech manufacturing, and new technology sectors as areas with the highest growth potential. “As an anecdote, taxi drivers on the roads of Beijing now anticipate a full switch to electric cars by the end of this year – a target that was delayed by the pandemic,” she added.

Challenging investment market

Investing in China’s dynamic market comes with an “evolving set of challenges and opportunities”, according to an update from FSSA Investment Managers. They noted robust recoveries in service sectors, such as catering, travel, and hospitality, but acknowledged manufacturing and property needed more time to recover. “Today, the key challenges include shifts in geopolitics, policy priorities and demographics,” they wrote. “In the shorter term, weak consumer confidence and rising unemployment have been additional areas of concern.”

Growth in a mature market

The FSSA team also addressed concerns about China’s slowing economy, including the potential to miss the 5% GDP growth target for 2023. They believe China will continue delivering steady, albeit lower, growth than previously, given the fact that it’s a more mature market.

“We can still find industry leaders who benefit from gaining market share over weaker rivals, or companies improving their returns and expanding their customer markets,” they said.
The team also pointed out many of the world’s most successful companies don’t grow their profits by 20%+ every year. Instead, they generate steady profits and reward shareholders with value.

Ways to access China

The good news is there’s no shortage of funds focused on China. For example, the Allianz China A-Shares fund is run by a very experienced and well-resourced team. The fund, which aims for long-term capital growth, concentrates on companies incorporated in China and listed as A-shares on the stock exchanges of Shanghai or Shenzhen. We particularly like the grassroots research that gives the team an extra edge in the region and believe this is a fund that can continue to do well in the future.

More flexibility

There’s also the FSSA All China fund. Unlike many portfolios covering this region, the fund invests across the whole market, including the aforementioned A-Shares. We like the flexibility of this fund, which aims to achieve capital growth over the medium to long term. It classes this as being at least three years. Although the fund has no set target for the number of companies it will invest in, it typically holds between 40 and 60 stocks.

A broader approach 

Another way to access China is through a fund that embraces Asia Pacific as a region. While China will often have a dominant position, this approach gives you exposure to other countries. For example, the Fidelity Asia Pacific Opportunities fund has exposure to Australia, Taiwan, India, South Korea, Hong Kong, Canada, and others. We believe manager Anthony Srom’s high conviction and disciplined approach helps this portfolio to stand out from its peers. He is a true active manager that focuses on finding the best available companies, rather than simply concentrating on a particular industry or theme.

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the author and fund managers and do not constitute financial advice.

Published on 15/08/2023