China has been a horrible place to invest since the start of this year. The average fund in the China/Greater China sector is down over 14%, as an unwelcome combination of geopolitical crises, regulatory uncertainty and rising Covid cases has hit sentiment towards the sector. Is this as bad as it gets for China? Or is there worse to come?
Gergely Majoros, member of the investment committee at Carmignac, outlines the wall of problems that have hit the world’s second largest economy over the past 12 months: “The uncertainty around the regulatory crackdown in tech, the restructuring of Evergrande, the expected delistings from US exchanges as well as the economic slowdown have all contributed to the increase in willingness of investors to exit the Chinese market.
“More recently, the ambiguous positioning of the Chinese leadership with regards to the Russian invasion of Ukraine, potentially suggesting a contagion of the Russian sell-off into the Chinese markets, has probably pushed the most stubborn international investors out of these markets.”
The question today is whether any of these questions are likely to be resolved. If this is the case, the current valuations would appear to be a good moment for investors to buy into the long-term growth story in China. Alternatively, if they look likely to persist, it may be a time for investors to cut their losses.
Pricing in extreme outcomes
Rebecca Jiang, portfolio manager of the JP Morgan China Growth & Income investment trust, says the group’s expected returns for equities are at all-time highs. She points to a range of Chinese companies where cash is more than 50% of market cap: “Markets appear to be pricing in extreme outcomes.”
She says that, without doubt, the economy has been cooling. “This has been ongoing since the second half of last year. A lot is driven by the property market cool off. More recently, concerns have risen because of Omicron cases in China, particularly in some of the mega cities such as Shanghai and Shenzhen. The impact on actual production and manufacturing business has been limited, but it has had a dent on consumption.”
It has also posed a significant challenge to the country’s much-vaunted ‘zero Covid’ policy. The repeated lockdowns have looked naïve and ineffectual in the face of a variant as transmissible as Omicron, but the Chinese government has shown no signs of changing its policy.
Elsewhere, however, there are moves to shore up the economy. Jiang points out that China was the only major economy in a tightening cycle last year: “Unlike most of the major economies elsewhere, China is entering into a clear loosening cycle and has abundant policy tools,” she adds.
Inflation in China is at a relatively low level with CPI below 1%. Interest rates are at a normal level, leaving scope to cut. Credit conditions are loosening and there is will on the part of Chinese policy makers to spend to boost growth.
There have also been significant fears over regulation with restrictions on key sectors, such as gaming and internet companies, plus cybersecurity and monopoly investigations. China’s Uber equivalent Didi recently had to suspend its listing plan because it failed to meet its requirements on cybersecurity investigations. Calls for ‘common prosperity’ have scared entrepreneurs, who fear wealth redistribution.
Minimising disruption in a crucial year for Xi Jinping
However, the Chinese government appears to recognise the problem. Majoros says that earlier in March, vice premier Liu He, the chair of the Financial Stability and Development Committee meeting, surprisingly addressed many of these market concerns in a constructive way.
“Regarding the future regulation of Chinese internet platforms, Liu announced a regulatory push towards a ‘traffic light regime’ and the intention of the authorities to facilitate a healthy development of these companies through transparent regulation. He also addressed the current issues of the fragile Chinese real estate sector, best represented by Evergrande, signalling that the credit support to the sector could be stepped up, especially the credit for the developers. In addition, he also stated that Chinese policymakers would continue to support overseas listings,” Majoros adds.
Geopolitics remains an unknown. There has been an increased concern over China’s apparent tacit support for Russia in the Ukrainian conflict. Any escalation of tensions with the US may increase the potential for a de-listing of Chinese companies in the US. However, China’s more collaborative stance with US regulators on ADRs is a positive step.
Another reason, perhaps, to be optimistic is that this is a politically sensitive year for the Chinese leadership. A crucial Communist Party congress will be held in the second half of the year and is expected to kick off another five years in power for Xi Jinping. All the senior leadership is tasked with minimising disruption in this crucial year. This may mean stronger action on economic growth and side-stepping global conflicts such as the Ukraine crisis.
This will all take time, but as Majoros says: “As we all know, waiting for all the stars to be aligned before acting is usually not a good strategy.” We may be closing in on an inflection point for the Chinese stock markets.
