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A disconnect is emerging between sentiment and fundamentals when it comes to valuations in Chinese equities. But this also creates opportunities to reposition for the country’s new modes of growth.
The immediate catalyst for this was the conclusion over the weekend of China’s 20th Communist Party Congress, upon which President Xi Jinping secured a third term as the top Chinese leader, and a new seven-member Politburo Standing Committee, China’s most powerful political body, was also announced.
Foreign investors reacted initially with high levels of selling through the Northbound Stock Connect on Monday, but we believe economic growth remains a key priority for the Chinese government. Instead, the kneejerk selling ignored fundamentals and potential beneficiaries of shifting policy focuses.
New policy statements indicate China is seeking to rebalance its economy with emphases on national security, low-carbon growth, and social equality under the “common prosperity” banner. There should be investment opportunities in areas like high-end manufacturing, electric vehicles, renewable energy, smart grids, digital economy and innovation, where there is greater policy support. Companies contributing to China’s import substitution and self-sufficiency drive should also benefit.
Before drawing conclusions, we need to watch the new leadership’s performance as well as key events like the upcoming Central Economic Work Conference in December, which will provide more clarity on sector policies. National People’s Congress meetings in the spring will also shed light on the country’s new economic growth targets, and possibly more fiscal stimulus.
Finally, we believe the country is set to fine-tune its zero-Covid policy and gradually ease travel restrictions next year, providing a boost to the Chinese economy. In addition, China has so far had relatively mild inflation, allowing its central bank to pursue further easing when necessary.
Below we set out some of the asset-class specific views from our portfolio managers on how the situation in China will develop.
Asset class insights
Asia Fixed Income Team
While we believe policy direction remains unchanged in China, there could be some degree of consolidation of strategy. Growth is still the top priority for China to build a modern socialist nation under the notion of “common prosperity”. This puts an increased emphasis on high quality economic development through growth drivers such as technological innovation.
The aim for a more efficient wealth redistribution mechanism may also spur consumption demand. Meanwhile, national security will be a more important consideration in policy making.
Given the government’s focus on the green transition, we expect to see more policy support on sustainability. Green-energy and carbon-neutral initiatives will remain in focus. The growth of ESG-labelled bond issuance in China is likely to continue, which creates more investment opportunities.
In this context, we continue to evaluate the risk-adjusted return available from China investment grade paper and focus on names and sectors with pricing dislocation. There is also emerging value from the Asia ex China space amid the recent market sell-off. This creates a good entry point to capture names with similar risk-adjusted returns for risk management and diversification benefits. We continue to monitor how the renminbi fares against the US dollar, given dollar strength is expected to continue.
Asia Equities Team
We are still in a bear market and the economic recovery is going to be gradual, so being defensively positioned remains key. We seek further clarity on how to turn the economy around, as economic policy is not as clear as the market was expecting given where we are in the cycle. To this end, we expect that economic support measures and policies will be elucidated in the near term as the leadership will need to acknowledge slowing growth.
That said, the People’s Bank of China still has the toolkit to support growth where needed, placing China at the other end of the policy spectrum versus many other economies or countries. With national security at the forefront of policy, self-sufficiency and import substitution will be major themes over the next five years and may offer investment opportunities. There are some concerns from Internet and consumer-focused companies, indicating there is a reduced appetite for spending on marketing and branding, but despite these idiosyncratic factors the recent sell-off has been somewhat indiscriminate.
Against this backdrop, we are focusing on areas of the market that are less impacted by regulatory and geopolitical risks and those that have strong policy support, while also maintaining strong valuation discipline. The reiteration of sustainable growth along with a focus on social and environmental considerations is positive for the trajectory of ESG improvement for Chinese firms.
While China is maintaining its zero-Covid policy at present, the mainland’s continued progress on vaccine development, along with the gradual reopening of Hong Kong and Macau, provides scope for an orderly and timely exit from the current policy in due course.
With geopolitical uncertainty and the US sanctions on tech-related companies, China is looking to reduce disruption and build national champions across supply chains. The recent expansion of these sanctions has sped up this process, and signals from the Congress show a willingness for this to happen. We are already seeing policy support via tax breaks and direct spending, which offers these firms an opportunity to gain market share from foreign competitors.
Multi Asset Team
National security, modernisation and science and technology seem to be priorities in President Xi’s strategy. We will also look for possible shifts in fiscal and monetary policies. The policies taken might favour some sectors of the economy such as aerospace and software developments and we could see import substitution developing. As the full policy picture emerges, its various elements will have important impacts not only on Chinese but also on global growth.
Emerging Markets Team
The market response to Congress has been severe and reflects a continued deterioration in sentiment. We had become increasingly cautious since late summer and exposures to areas of the Chinese market affected by the recent selloff were limited. That process of reducing exposure to the market continued through September and into October.
Where we are exposed, the focus is on high quality, robust businesses positioned to weather a challenging economic environment. As valuations reach more and more extreme levels, we will continue to scour the market for opportunities, with a medium to long-term view, however, with the benefits of a very broad investible universe, we may look for compelling opportunities elsewhere at this juncture.