After three years of stringent zero-Covid policies, the Chinese Government finally capitulated in December 2022 and confirmed a decisive pivot to a renewed focus on economic growth as the nation’s top priority. At a corporate level at least the reopening of the economy has been smoother than expected – initial data on both the consumer spend and factory output sides of the picture indicate a surprisingly fast return towards pre-Covid levels. Consensus predictions are for a virtual doubling of GDP growth to in excess of 5% in 2023. And having been in negative territory in 2022, consumer spending is expected to rise by around 7% in the current year.
These developments have all been very clearly reflected in the performance of the Chinese equity market over the past three years. Coinciding with the introduction of severe Covid restrictions in early 2021, the Chinese equity market began a steady slide downwards, a slide that continued right up to the lifting of the restrictions at the end of 2022. The market then bounced strongly in the three month period to end January but gave back some of those gains in the subsequent two months.
The question for investors now of course is does China represent a buying opportunity at current levels?
Well the first point we cannot ignore of course is that China is the second largest economy in the world. Even with the brakes being applied during the Covid restrictions, it remains the fastest growing of the major economies and, based on current trends, will considerably narrow the gap with the US over the next decade. In addition its economy is materially larger than Japan, Germany and India combined, its three closest rivals. While the anti globalisation trends which emerged during Covid (resulting in countries looking to onshore or near shore their sources of key materials) is arguably not a welcome trend from China’s perspective and will slow trade growth, the reality is that internal consumption and trade with near neighbours in Asia are becoming increasingly important for China. Mirae Asset Management, a specialist in Asia investment, estimate that by 2024, China will account for 19% of global GDP by nominal value and 21% of global GDP by purchasing power.
And China’s businesses are confident about the growth outlook with hiring intentions rising to their highest level in eight years in February. This was in the wake of the strong rise in the Purchasing Managers Index in January which clearly reflected the widely held view amongst companies that the emergence from Covid represents the best growth opportunity in more than a decade.
And it is hard to argue that Chinese equities are expensive following their Covid-related slide. In October last, Chinese shares trading in Hong Kong fell below the lows experienced post the global financial crisis in 2008 and the Chinese equity market currently trades on a multiple of 10-12 times, almost half the US multiple. So if we are looking at a combination of a cheap stock market, the world’s second largest economy and a growth rate well ahead of developed nations, what’s not to like? Well there are at least three important considerations to bear in mind around China which may give investors pause for thought.
The first point to make is that Chinese industry has a very poor record of converting GDP growth into profitability and returns on capital. Since 1994, Chinese GDP has risen by a factor of 25 while overseas investors in Chinese shares (via their Hong Kong listings) have seen a negative return over the same period. While there are many factors at work here, a major influence has been the tendency of many Chinese companies to chase growth at any cost to the detriment of building real value.
The second point is debt. Chinese growth over the past decade has been accompanied by a sharp rise in consumer and corporate debt levels. The debt problems of a number of large property investment vehicles have been well publicised but the growth of consumer debt (mainly mortgages) should not be ignored either.
The third point is politics. No company in China operates completely free of political influence or involvement and any investment in a Chinese company needs to take account of this.
On account of the above, successful investment in the Chinese market needs to be highly selective and should focus on companies with proven track records, well managed balance sheets and operating in sectors less likely to attract political attention. In terms of economic sectors worthy of attention post Covid, leisure, consumer staples and healthcare all look attractive – the right companies in these sectors have the potential to deliver real value over the coming years. So to answer the question in the title, we would feel the answer is certainly yes but a highly qualified yes.
