Will China’s markets roar again in the Year of the Tiger?, January 2022

The Chinese New Year is almost upon us, with millions of people across the globe set to celebrate. Festivities to mark the occasion run for a full two weeks and there are national holidays in the likes of Indonesia, Vietnam, South Korea, Malaysia, North Korea, and Taiwan. But following recent volatility, will China’s markets roar again when the Year of the Tiger begins on 1 February?

Those born in the Year of the Tiger are said to be brave, competitive, unpredictable and confident. And the reality is that investors in Chinese equities have traditionally needed most of those traits – but particularly in the past 12 months or so.

Here, four portfolio managers give their views on the outlook for Chinese equities:

“After a very strong run in 2020, Chinese equities struggled through 2021, said Robert Secker, portfolio specialist at T. Rowe Price, whose Asian Opportunities Equity fund has a 37.9%* allocation to the asset class. “There are a number of reasons behind that marked rotation in performance; China’s latest regulatory cycle, a slowing economy, high valuations going into the sell-off, but importantly it is also due to index composition.

“China is an incredibly deep, diverse investment universe of over 5,500 companies. However, the primary China indices are very concentrated and dominated by a handful of internet and e-commerce companies. These mega-caps performed relatively well with the onset of COVID in 2020, before struggling in 2021 as many found themselves the subject of China’s latest regulatory cycle which looked to target those companies unduly benefitting from monopolistic practices.
 
“Moving into 2022 we believe that China’s enormous investment universe presents abundant opportunities for active investors. There is a huge opportunity set outside of China’s mega-caps which is overlooked, under-owned and home to some incredibly innovative, dynamic companies. We are optimistic that this year should be a better one for Chinese equities; the government is shifting focus away from regulation towards accommodative economic policies (at a time when most of the West are thinking of tightening) and valuations look attractive.”

Valuations look attractive

Rob Brewis, co-manager of Aubrey Global Emerging Markets Opportunities, says sentiment towards Chinese stocks is at a low ebb, but with reason. “Beijing’s regulatory stance has hardened against certain business practices, the property market is under a cloud and, for good measure, growth stocks have taken a clobbering as investors worry over rising interest rates,” he said.

“The fall from grace has been well documented. However, we believe this negativity goes well beyond the likely outcome: investors are not taking notice of what the savage share price declines have done to valuations of high-quality Chinese companies whose businesses continue to do well.

“We wouldn’t go bottom fishing in the highly leveraged and largely bust property sector, and few state-owned enterprises meet our cash return and profitability criteria. But dig a bit deeper and there are rafts of entrepreneurial companies which are operating in areas of the economy witnessing structural and rapid growth, have little or no debt, have strong or improving operating cash flow and return on equity, and are now very attractively valued.

“We believe many of the major headwinds for the Chinese stock market are either dissipating, or now largely reflected in share prices, or both. But while the rest of the world is mithering over interest rate rises, China is actually cutting them. We believe that other forms of government support will also be forthcoming.

“Timing of course will be critical but there is a clear fundamental argument for the long-term investor to be adding to his/her exposure. To us, the year of the Tiger looks much more promising than the outgoing Ox.”

Invest in strategic priorities

“Recent market turbulence in China may have attracted attention, but the country’s transformation story is far from over,” says Anthony Wong, co-manager of Allianz China A-Shares. “The Year of the Tiger could offer multiple opportunities for investors, notably around sectors related to China’s future technologies and climate programmes.”

Anthony says there are options for investors wanting exposure to Chinese equities. The first is to seek out opportunities in sectors linked to China’s strategic need for self-sufficiency, such as semiconductors and robotics, and stocks linked to China’s carbon-emissions targets like renewable energy and the electric vehicle supply chain. “Despite potential headwinds from the supply side (possible shortages of electricity and chips), we expect these sectors to continue to underpin China’s growth,” he said. “Themes relating to social trends like increased family sizes (incorporating branded baby clothes and food) and healthier lifestyles will also likely emerge.”

He also thinks it’s important to learn how policy shapes the future. “It is essential to understand China’s economic, social and cultural history – and how its policy agenda is evolving,” he said. “This can help investors discover where the country’s strategic priorities translate into opportunities. Those sectors that are central to the country’s planned transformation should continue to enjoy political support and are consequently also less likely to be affected by regulatory change.”

More than just tech opportunities

Sharukh Malik, a member of Guinness Global Investors’ Asian Equity team, whose Asian Equity Income fund has a 30.1%** allocation to Chinese companies, agrees there are numerous structural growth themes in China. “The country is so much more than just tech stocks,” he said. “Interesting themes include China’s manufacturing upgrades and move up the value chain, sustainability and healthcare. Furthermore, companies giving exposure to these themes are not affected by tech regulation.”

“We also think the government is likely to loosen fiscal and monetary policy in 2022,” he continued. “We expect this to lead to an improvement in growth and sentiment towards China, potentially leading to a rerating.”
 
But there are also reasons to remain cautious, including Omicron and the property market. “While China has had success in preventing outbreaks of previous strains, this is going to be much harder with Omicron, in the context of China aiming for zero-covid,” Sharukh continued. “Property – and in particular persistent concerns over the fallout from Evergrande – is another concern. The Chinese property market is currently very weak, and in response, the government has already cut rates on mortgages this year.”

*Source: fund factsheet, 31 December 2021
**Source: fund factsheet, 30 November 2021

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.