By Jean-Louis Nakamura, head of the Vontobel Conviction Equities Boutique
The common perception of Dragons in the Chinese zodiac is that they are strong and independent figures who also yearn for love and support – characteristics that apply very well to Chinese markets in the present context.
With a year-on-year growth estimate of 5.2% at the end of 2023, China’s GDP was in line with its objective to grow around 5% defined one year ago.
Nevertheless, such a result has hardly be seen as exciting. It has been achieved almost exclusively thanks to the strong pick up in consumption of domestic services during Q1 and early Q2, from the extremely low base of 2022 when major Chinese cities were under very restrictive lockdowns.
Since spring 2023, Chinese growth has been stalling, reflecting an economy plagued by its structural problems. For obvious reasons, the tactics it used in the past to recycle excess savings through exports, infrastructure and real estate are not working as they used to do.
Many economists have called for a massive stimulus plan to inflate consumption and put it back on track. However, authorities – as part of their fight against moral hazard and “disorderly allocation of capital” – are still reluctant to proceed.
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The paradox is that by trying to solve past imbalances, Chinese authorities are creating new ones. They are accumulating resources, monetary and fiscal incentives in the manufacturing sectors such as EVs, semi-conductors, solar panels at the high risk of over-capacities, depressed margins, and further deflationary dynamics.
While the risks of a financial crisis are overrated, the prospects of a sizeable and sustainable recovery look very limited at this stage. And stocks markets, despite incredibly attractive valuations, are reflecting this lack of traction, with roughly $7trn of market capitalisation being wiped out over the past three years.
Recent rumours of stabilisation plans – most of which have been restricted to the old recipes of mobilising large public institutional investors to buy Chinese large caps – have triggered spectacular short-term bounces, mostly fed by hot money. However, in absence of credible solutions to lift China’s economy out of its deflationary trap, long-term domestic and overseas investors will not come back so easily.
This situation is all the more frustrating since China’s economy offers a tissue of incredibly innovative companies at the edge of their respective frontier in terms of capital productivity. In an environment so dominated by policy preferences, picking the best performing Chinese stocks has become extremely complex.
While favouring state-owned enterprises (SOEs) with high operating margins in traditional industrial or energy sectors could be a safe bet in the short-term (many energy producers are up between 15% and 20% year-to-date), long-term future winners will be found in crossing themes sheltered from excessive policy influence, with high and stable level of profitability and robust demand tailwinds, that would allow them to compound value at a much faster clip than the rest of the economy.
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