China was the best performing equity market in the world in 2020 but has struggled to match that growth in 2021 so far. The rapid post-Covid 19 economic recovery appears to have run out of steam, while government intervention in the tech sector has unnerved global investors. China’s high-growth tech stocks like Tencent (00700) and Alibaba (BABA), have also fallen out of favour as value companies have staged a dramatic comeback. We look at the outlook for China this year and beyond and the key themes for investors.
The Trade War Isn’t Over
Tension between the US and China ramped up during the Trump era so there were high expectations for a reset in relations during the new Biden presidency. But in many ways the trade war lives on and continues to have an impact on economic policies. China’s self-reliance and drive to strengthen regional ties remain key themes too. The Regional Comprehensive Economic Partnership (RCEP), a trade agreement signed late last year including China and Japan, will create the world’s largest trading bloc. Kiran Nandra, an emerging market specialist at Pictet, says this is a huge boost for the region, creating a powerful geopolitical bloc to take on the US.
Within China, “import replacement” is a key strategy across many industries including manufacturing and technology. From semiconductors to solar panels, “China is seeking to localise more supply chains,” says Helen Chen, co-manager of the FSSA Greater China fund, which has a Morningstar Analyst Rating of Gold. To bolster the domestic economy, China has identified some key "strategic emerging industries”, including artificial intelligence, 5G rollout, renewable energy and electric vehicles. Fund managers expect this drive to create more national champions in the coming years, with the winning companies building market share from a low base.
Beware Regulators
Which market these companies of the future list on is a hot topic and will have an impact on how global investors access Chinese stocks. The latest example of Chinese regulators getting tough with tech companies is DiDi (DIDI). This ride-sharing company listed on the New York Stock Exhange (as Alibaba did in 2014), only to be told days later that its app would be banned in China, causing its share to plunge. The incident reminded investors of when Ant Group’s planned IPO was pulled after a disagreement between Beijing and Alibaba founder Jack Ma. China’s Cyberspace Administration is now concerned about how tech companies use customer data; companies with over 1 million users that plan to list overseas now have to undergo additional scrutiny. Rather than an isolated incident, for FSSA’s Chen, the Ant/DiDi sagas will encourage more companies to list in China and Hong Kong in the long term.
Given the importance of tech companies to China’s appeal to investors, should overseas investors be concerned? Dale Nicholls, manager of the Fidelity China Special Situations investment trust (FCSS), thinks China is really just catching up with the West in terms of data protection and that regulation is long overdue. “Companies have to rein in their exploitation of data … and all countries are going to be thinking about data differently,” he says. From an ESG perspective, this is to be welcomed, he adds, and goes hand in hand with companies looking to improve relations with employees too.
Pictet’s Nandra thinks the crackdown will lead to a more healthy “commercial ecosystem”, improving competition in the long run and ensuring a level playing field for smaller and medium-sized companies.
Sectors to Watch
Tech was the place to be for investors in China last year as the country bounced back dramatically from the coronavirus crisis. Now the economy is starting to enter a “normalisation period”, says Rebecca Jiang, manager of the Silver-rated JPMorgan China Growth & Income trust (JCGI). While this means growth is slowing from last year’s pace, the risks of overheating have started to fade. The country’s central bank has eased lending requirements for the finance sector, which should increase loans to SMEs.
So where are fund managers finding opportunities? Jiang is keen on healthcare and biotech stocks, and smaller companies in the software and automation sectors. She likes Tesla rival Xpeng (09868), which floated in Hong Kong this month, because it customises its cars for local Chinese consumers. In this crowded space, Fidelity’s Nicholls is keeping an eye on Xiaomi (01810) a smartphone maker that announced earlier this year that it is pivoting towards electric vehicles.
Meanwhile, FSSA's Chen is looking for resilient companies in sectors that are “economy neutral” whatever the headline rate of GDP is this year. “Consumer demand is not particularly strong,” she says, which is why she plans to position the portfolio towards stocks that can pass on any uptick in inflation to customers. She is increasingly positive on the tech sector, which has struggled this year, and is also keen on healthcare because it will continue to benefit from increased spending from consumers and the government.
