Perspective

Why investors should stay positive on China


There is a familiarity that seems to be returning to life in mainland China. Amid all of the ongoing global uncertainty as a result of the pandemic, some may find it hard to believe that the situation in mainland China has normalised so quickly.

Yet this is precisely what I found on my recent visit to Shanghai from Hong Kong. In fact, traffic congestion was as bad as it was in the old days, before the need for lockdowns and other restrictions. Restaurants, meanwhile, were once again packed. Besides the mandatory two-week quarantine on arrival, I saw few signs of the health crisis.

We think the recovery will continue, aided by supportive policy and a robust test and trace programme. This should in turn continue to be positive for the performance of mainland stock markets.

How is the economic recovery evolving?

After shrinking 10.0% quarter-on-quarter (q/q) in the first quarter of the year, the economy bounced back in the second quarter, expanding by an impressive 11.5% q/q.

Industrial activity has led the recovery, and manufacturing is returning to more normal levels of operation. Although data in areas such as retail sales have also improved persistently, the consumer sector has lagged; partly due to weakness in areas such as travel, which are yet to fully recover.

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Overall, China has navigated the crisis relatively well, and apart from interactions with other countries, most domestic activities are back to a pretty normal state. You can see this clearly in the recovery in activity indicators, illustrated in the chart above.

What is the outlook from here?

We think that economic activity will remain strong over the next few quarters at least. This is underpinned by the proactive steps taken by the government earlier this year, in response to the impact of Covid-19.

In order to restart and support the economy post the pandemic, various stimulus measures were unveiled, with budget for additional spending earmarked.

This included a special purpose bond issue from the central government. In addition, prior to the pandemic, the government had already increased the local government bond issuance quota. This money will be put to use to fund infrastructure growth, as well as investments aimed at improving public wellness.

Meanwhile, monetary policy easing from the People’s Bank of China earlier this year should also prove beneficial, though there is typically a lag before its impact is visible.

Could record bank lending and credit stimulus have implications for the property sector?

Property-related construction has historically been a large contributor to economic growth in China. There is naturally a concern that with monetary loosening from the central bank, some funding could find its way into the property markets and spur a strong pick-up in market prices.

However, the Chinese administration has adopted a firm policy stance in recent years. The central government has been consistent in its view that “houses are for living and not for speculation”. This is encouraging.

And the government has not been afraid to intervene when required. It has generally sought to control bank lending to developers in order to manage property supply, while on the demand side the government has the ability to manage down payment requirements and loan-to-value limits via the banks.

Moreover, broader purchase measures have been deployed. For example, under so-called Hukou restrictions, individuals are restricted from buying property in cities where they do not reside. Evidence of a job and social security contributions are required. 

These measures are working, even in high economic growth areas such as Shenzhen. In that city, which had previously seen sharp increases in property prices over short periods of time, the local government introduced restrictive policies to manage price rises.

So in spite of monetary loosening, we are not witnessing significant flows into the property sector.

What are the risks?

As with other countries, the reality is that the risk of a resurgence in the virus remains. This could result in renewed restrictions on movement and a consequential impact on economic activity. However, China has so far proven adept at bringing down and controlling infection rates. 

Geopolitical tensions, on the other hand, appear likely to persist. This may be in the form of further restrictions on the technology sector, for example.

And while such measures may have some impact, not least on sentiment, we think the economic impact would be manageable. The domestic economy, for example, is increasingly driven by what the government calls ‘internal circulation’ or domestic production, distribution and consumption.

Where are the market opportunities?

The market has performed strongly so far this year. But that’s not stopping us continuing to find attractive opportunities in the China A-Shares market – that is, the mainland stock markets of Shanghai and Shenzhen.

We have for some time favoured companies which we believe are best positioned to benefit from long-term growth trends. These are in sectors such as electric vehicles, a multi-year secular story in our view, as well as 5G and industrials which are beneficiaries of automation.

We are seeing Chinese companies become more self sufficient, increasing investment in research & development, and becoming more competitive in the longer term.

If the economic recovery continues to take hold, and gathers momentum in 2021 as we anticipate, we think there may be some opportunities among sectors more sensitive to the economic cycle, such as materials.

In sectors that are forecast to grow strongly regardless of wider economic growth, there are undoubtedly cases where valuations are elevated. Nonetheless, even in these sectors we are still finding companies whose growth potential remains underestimated.

 

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