China is back in the international spotlight again with two key events this week: the beginning of the Year of the Tiger on Tuesday, and the Winter Olympics in Beijing on Friday.
Investors will be hoping the new lunar year will bring better fortune than the Year of the Ox, which lumbered to a close yesterday. Chinese government intervention in key sectors has spooked markets, while the wider global tech sell-off at the start of 2022 has dragged in China too. As if that wasn't enough, the Evergrande crisis too reminded the world of China’s potential to overheat in sectors like property.
In 2020 China's speedy pandemic bounceback made it the best-performing stock market in the world, but that feels like a long time ago these days. The country is now pursuing a Covid-19 containment policy that could hold back certain elements of its economy like construction. The Morningstar China index was down 21% in 2021, after 2020 gains of more than 30%. The index is down nearly 5% since the start of this year.
While Morningstar's coverage includes a range of emerging market funds, they are dominated by Chinese stocks, and only two China-specific funds are rated Bronze and above: FSSA Greater China Growth, which is rated Gold, and JP Morgan China Growth & Income (JCGI), a trust rated Silver. The FSSA fund managed to buck the trend of index weakness by posting gains of 4.7% in 2021, following a gain of 27% in 2020. The share price of the JP Morgan trust fell 25% in 2021, after a stellar 95% rise in 2020.
Below, we look at some key themes for China's Year of the Tiger, compiled with the help of some fund experts.
Regulation
Beijing’s reach extended from education to computer games last year and investors took fright at both the extent and suddenness of the intervention. Under the banner of “Common Prosperity”, Xi Jinping showed the government’s power to shape the economy at will, providing yet another reminder of political risk to fans of emerging markets.
Dale Nicholls, manager of Fidelity's China Special Situations investment trust (FCSS), thinks a certain amount of turmoil will be beneficial for the economy in the long run.
“There is a good chance we are well into, if not past, the peak of regulatory reforms, particularly within the technology sector – I would not expect the same degree of intensity that we saw last year and at the end of 2020 to continue.”
Beijing’s aim to spread China's rising wealth could be seen as opportunity, adds Jimmy Chen, manager of the Comgest Growth China fund. “Stock pickers like us need to build government agenda and regulatory risk into their stock selection. We ask ourselves whether our portfolio stocks are aligned with the government goals or not. It is as simple as that.”
Examples of challenger brands to tap into rising incomes are jeweller Chow Tai Fook, sportswear brand Anta and consumer appliance firm Midea, all home-grown successes.
Valuations
At the end of 2020, the consensus was that China's equity market was now richly valued, if not overvalued. Now the opposite could be argued after a bruising period for investors. While the great unwinding of the US tech bubble may have just started (my colleague John Rekenthaler argues that this is what is happening) Chinese stocks have already been through the bubble and beyond, argues FundCalibre managing director, Darius McDermott.
“The savage share price declines of the past six-to-twelve months have left the valuations of many high-quality Chinese companies at much more attractive levels and many of the major headwinds for the Chinese stock market are either dissipating, or now largely reflected in share prices, or both," he says.
Chinese equities are trading at a 35% discount to US ones, the biggest since the 1990s financial crisis, says Jacob Mitchell, founder and chief investment officer at Antipodes Partners. Some companies are still looking pricey despite the sell-off, though, argues Wenchang Ma, co-portfolio manager, All China Equity, Ninety One.
“Some Chinese companies are trading on excessive multiples, way ahead of their earnings potential,” he says.
Inflation and Rate Rises
While the western world braces for a series of rate hikes to tame inflation, China appears to be going in the opposite direction, loosening monetary and fiscal conditions. “2022 could be the year inflation takes off around the globe. If so, China might prove a refuge as inflation remains low and monetary policy is easing,” says Comgest’s Chen.
Meanwhile, in China itself the argument for more accomodating policy (effectively bringing money for troubled sectors like property) has gained the upper hand. That's the stance of Mirabaud Asset Management chief economist Gero Jung. Commercial banks are lowering the loan rate, which should support the housing market.
Supportive measures by China’s central bank, the PBOC, could help equity returns too, at least in the short term, says Janet Mui, head of market analysis at wealth manager Brewin Dolphin. “This increase in liquidity is historically an important driver for rallies in the Chinese stock market – arguably more so than economic or corporate fundamentals," she says.
Geopolitics Ever Present
China’s economy and stock market may put in a decent showing in the Year of the Tiger, but at what cost? There are plenty of reasons for investors to be anxious about the bellicose nature of the Xi Jinping regime. The end of the Trump era has not signalled a new détente in US-China relations, and the trade war between the two nations is alive and well. Moreover, recent crises, from Kazakhstan to Ukraine, have strengthened Russia’s power and drawn it towards China against the West.
In the Pacific, China is expanding its naval power, troubling Japan and Taiwan in particular, and unrest in Hong Kong remains a live situation. The Winter Olympics is also drawing attention to China’s treatment of Uyghur ethnic minorities – this weekend’s New York Times carried a full-page advert by Elie Wiesel Foundation for Humanity, the human rights charity set up by the Holocaust survivor Elie Wiesel. The ad called on athletes and corporate sponsors to boycott the games unless Beijing takes steps to reunite Uyghur familes.
Guy Monson, chief investment officer at Sarasin & Partners, says Beijing continues to set itself at odds with the US and other trade partners.
"China’s tilt away from the West intensified in 2021, with its greater assertiveness towards Taiwan, tighter security regime in Hong Kong and restrictive economic policies targeted at countries including Lithuania, Canada and Australia,” he says.
And Chetan Sehgal, lead portfolio manager of the Templeton Emerging Markets Investment Trust (TEMIT) notes the US-China political standoff continues to affect where companies from both countries list. "The US recently finalised rules to force the delisting of Chinese companies from US stock exchanges if they fail to comply with US audit inspections and other requirements," he notes.
