Outlook 2023: China

China’s economy

We expect China’s economy to stage a recovery in 2023, although we think exports are likely to contract in 2023. This is because we expect many developed market economies to fall into recession as high inflation and interest rates choke off demand.

The expected slump in exports puts the onus on domestic demand to drive any recovery. A combination of the zero-Covid policy and collapse in activity in the real estate sector have weighed on domestic output and consumer confidence.

However, there are reasons to think there will be improvement. Infrastructure spending has been buoyant in 2022 and should underpin growth for a while longer as policy remains supportive. Meanwhile, the housing market could stage some recovery in 2023. The service sector would clearly benefit from any loosening of Covid restrictions that may emerge during the course of the year. This would help to unleash the cyclical recovery that leading indicators have been suggesting for a while will get underway in earnest as we head into 2023.

Recovery in China GDP expected in 2023

The upshot is that our base case remains for GDP growth to pick up, from an expected 3% in 2022 to around 5% in 2023. We expect the economy to stage a cyclical recovery in the near term.

China equity markets

China equity markets will likely continue to be influenced by the global macroeconomic backdrop, particularly the extent of future rate hikes and whether the US and EU experience soft or hard landings in terms of their economic slowdowns. A peak in the US interest rate cycle could take the heat out of the US dollar, which should help liquidity in emerging market economies.

Domestically, recent developments suggest a gradual move away from China’s zero-Covid policy and we expect to see more pragmatic implementation of Covid policies in 2023. That said, economic growth momentum could remain somewhat volatile.

The government has recently become more supportive of the property sector, rolling out a set of measures to boost developer financing in November 2022. However, it will likely still take some time for the sector to more fully recover given the softer economic backdrop. We remain selective in terms of our investments in this space.

US-China tensions and geopolitics will likely continue to drive volatility in Chinese equity markets. Recent announcements like the US CHIPS and Science Act – which will see major investment in research and development of semiconductors in the US - highlight the real impact that geopolitics can have on industries in China.

Supply chain safety and self-sufficiency will remain a key priority going forward in our view. As such, we expect to see an acceleration in investments into areas of strategic importance like technology, military, and supply chain independence. We also anticipate that de-globalisation trends will continue.

With Chinese equity markets trading at more than one standard deviation below long-term valuation levels, the market’s risk-reward profile looks reasonably attractive in the short term.

Markets could rebound sharply if we continue to see signs of an economic re-opening and/or a gradual move away from zero-Covid, or further efforts to support the property market.

Favour sectors that run alongside policy priorities

IT and industrial names should benefit from supply chain localisation and industrial automation upgrading. Meanwhile, renewable energy companies (solar and wind) can capture increasing investment into the environment and the focus on a greener China. We also favour construction machinery, in anticipation of a pick-up in infrastructure spend, and consumer names and companies that may benefit from a re-opening of the economy. The healthcare sector is also becoming more attractive after significant corrections over the past year.

On the internet/e-commerce sector, top-line (revenue) growth should start to recover in 2023 as economic growth improves, but in contrast to the past where the sector traded at a significant valuation premium to the market, we would expect these companies to trade like consumer cyclical names, which should be valued more or less in line with their earnings growth potential.

We continue to take a bottom-up approach to investing, with allocation between the offshore and onshore markets reflecting the opportunities we see at a company level. While valuations in the offshore market currently look more attractive, onshore markets may be better supported over the medium to long term given the greater number of stocks that provide alpha opportunities.

China debt

The outperformance of Chinese onshore bonds so far in 2022, as well as during the pandemic in March 2020 and in 2021, demonstrates the asset class’s resilience and diversification benefits. Indeed, international investors increasingly perceive it as something of a “safe haven”.

China bonds outperformance

Going into 2023, the outlook for Chinese onshore bonds looks positive, especially if US dollar strength reverses.

The longer-term case remains compelling too. The monetary policy backdrop is supportive and China’s capital markets are becoming increasingly accessible. Meanwhile, Chinese bonds are increasingly being included in major global bond indices, bringing China into the investment universe for more international investors. The internationalisation of the renminbi (as it increasingly becomes more of a global currency for trade, investment and foreign exchange reserves) is also supportive. The low volatility and diversification benefits of the asset class also remain appealing.

We have recently upgraded our growth outlook for China’s bonds following the recent spate of measures that have been implemented to support the property sector. The authorities also appear to be gearing up for a gradual re-opening of the economy in 2023 given recent moves to ease the country’s zero-Covid policy.

The relaxation of Covid curbs will likely focus primarily on reviving domestic demand, but the ensuing improved mobility within China should help consumer and business confidence to recover from current levels.

In terms of interest rates, our view is that Chinese government bond yields will likely be range-bound (that is, trading in a narrow range) and stable going into 2023. This is because muted inflationary pressures with a modest pace of economic recovery mean that the People’s Bank of China should tend towards keeping monetary policy accommodative and liquidity ample. Moreover, with the yield curve still positively sloped (that is, short term bonds have a lower yield than longer-term bonds), exposure to Chinese bonds could be a good place to be for carry (or income), in our view.

Over the longer-term, we believe common prosperity, regulatory reform, ongoing deleveraging and the country’s ageing population are themes that are supportive of bond investments.