PERSPECTIVE3-5 min to read

China’s domestic rebound likely a booster for the markets

21/02/2023
China SHanghai

Authors

Jack Lee
Fund Manager

Following the easing of Covid restrictions and borders reopening, economic activity in China, particularly consumption, has started to resume. While the current macroeconomic environment may cast a shadow over global exports, and the Fed may still continue with its rate hikes, China’s domestic demand remains robust. We expect 2023 to be a year of recovery for the Chinese economy. The market is on track to rebound from the troughs in 2022, and its GDP may grow by 5% in 2023.

Recovery in China GDP expected in 2023

Policy supports growth across sectors, which will be beneficial for markets

Over the past few years, Chinese consumers have reduced their spending amid Covid restrictions. As a result, household savings have registered strong growth. Major risks affecting the market such as Covid and real estate woes have faded, and the policy environment has become more favourable. The fact that China has managed to keep inflation low even as high consumer prices sweeps across most of the world points to the market having greater leeway to continue with monetary policy loosening. All these factors bode well for China’s economic recovery and the A-share market.

The Chinese central government’s efforts to press ahead with its “common prosperity” policy and to expand its middle class should help shape a more resilient economic framework in the long run. Driven by recovering consumer confidence, a boost to mass consumption is also expected to shore up earnings across various industries.

Guided by the principle to “not engage in speculative buying of housing”, China’s real estate sector experienced a deleveraging process in the past two years, which left quite a few property developers financially strapped and many development projects unfinished in certain cities.

Since the fourth quarter of 2022, government authorities have started to lend support to the real estate market, with an aim to encourage healthy development within the sector. Besides rolling out measures to ensure a timely delivery of presold homes, different governmental bodies have introduced coordinated policies to expand financing channels for stressed private developers in order to ease their financial pressure.

At the same time, certain lower-tier cities have loosened their policies for home purchases by offering lower mortgage rates for first-time homebuyers, with an emphasis being placed on meeting reasonable demand for housing. All these factors are favourable for the real estate market.

Even though there is still some way to go before investor confidence is fully restored and there may still be doubts over the long-term solvency of certain developers, we believe that supportive governmental policies can bolster the domestic real estate market, which is also an important means to a stable economy.

All in all, we are optimistic about China’s overall economic prospects.

The A-share market turns more positive as prospects improve across sectors

It is true that China’s stock market will remain subject to potential global macroeconomic risks such as the U.S. interest rate trajectory and a likelihood of recession in Europe and the US, but A-shares are currently fair-valued. Should the US dollar weaken as interest rates peak, capital is expected to flow into emerging markets, which we think will likely benefit the Chinese equity market. In this regard, we are now more positive about the A-share market.

While many may think of tourism, duty-free retail and hospitality as the most hard-hit sectors due to the pandemic, these stocks actually have not seen steep falls as negative factors have perhaps already been priced in early on. Instead, advertising, cyclicals, as well as wedding and banquet-related sectors, as well as consumer services (such as “baijiu” or Chinese liquor) have suffered deeper losses. As the Chinese economy reignites its momentum, these sectors may be back on the upward trajectory and drive gains for related A-shares and Hong Kong stocks.

Apart from the consumer sectors, investors might also want to pay attention to industries that are expected to benefit from government policies and those with structural growth potential.

In response to the complicated global macroeconomic environment, the Chinese government is on its way to strengthen its self-reliance on key strategic technological fields. The emphasis on “high-quality development” as outlined in China’s 14th Five-Year Plan is aligned with plans to develop its high value-added industries.

One such example is the commercial large passenger aircraft industry that recently celebrated the delivery of China’s first domestically developed C919 passenger plane. The industry is expected to promote the development of a series of high value-added industries as China pushes ahead in high-end manufacturing.

With global concerted efforts to address climate change risks in place, China’s green energy and electric car industries look set to thrive. Currently, a number of Chinese listed companies in these industries are sector leaders globally, and they may offer investment opportunities for investors. 

Cyclical sectors such as raw materials are also noteworthy on the back of a recovery in demand. Some companies in China’s technological innovation cycle may benefit from import substitution and, in some cases, may become global leaders in cutting-edge fields. However, technology and consumer electronics companies may remain fragile in the short run due to weak consumer demand and a lack of significant new product launches. Therefore, we continue to hold a cautious view towards these sectors.

With weak global demand expected in 2023, export-oriented industries could be headed for another disappointing year. Investors will need to tread carefully, and it may be wise for them to focus more on companies that rely more on the domestic market, especially those in the consumer sector, instead.

Consumption in China expected to recover

Stay alert to risks and get prepared for volatility

Positive surprises from China’s quicker-than-expected reopening post-Covid has given domestic consumer demand a boost, and has lent strong support for corporate earnings. However, its recovery may still be affected by various factors. 

The progress of herd immunity after the optimisation of China’s Covid-19 response still needs further observation.  Policy-wise, the concept of “common prosperity” could be subject to potential risks, such as high housing prices and an aging population. At the same time, risks of recession in Europe, geopolitical events, inflationary pressure, and the global energy crisis may add to macroeconomic uncertainty. Investors should be prepared for market volatility stemming from these factors.

That said, we still believe that with every risk comes opportunity. Referring to past experiences, investing in A-shares during an economic downturn is like playing mah-jong, that is, a quickly changing market may offer decent entry points into the markets for investors. It may be worthwhile for investors to dig deeper, by analysing company fundamentals, including but not limited to their operating status, capital cost and cash flow, so that they can discover medium-sized, quality companies with great potential and capture structural growth opportunities.

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Authors

Jack Lee
Fund Manager

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