Will China’s economy soar in the Year of Loong?

The Chinese equity market performance in 2023, seeing three consecutive years of decline, has led to considerable disappointment among investors.

Following the lifting of stringent pandemic controls, China's economy did not swiftly rebound as anticipated, particularly sluggishness in the real estate sector continuing to weigh on sentiment.

“Loong” symbolises vitality, ascendance, and hope. Can China's economy embody these auspicious meanings and reverse its downturn this year? What role will economic policy play in this game, and which sectors represent fertile grounds for investment? Here are some commentaries and outlooks on China's economy from our fund manager partners.

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Market sentiment towards China may shift as strategic sectors show secular strength

PIMCO, Feb 2024

“The sentiment around China’s economy has been overwhelmingly bearish due to persistent headwinds, including a fragile property sector, geopolitics, demographics, and debt. But the Chinese government’s focus on several strategic sectors could help offset some of the drag. Our baseline forecast is for annual GDP growth to slow to 4.5%-5% in 2024 from 5.2% in 2023.”

“Fiscal resources are expected to be directed towards infrastructure investment in leading-edge sectors (such as the digital economy and artificial intelligence) and research and development for manufacturing upgrades to move up the value chain to higher-tech, higher-value products (such as electric vehicles, renewables, and aerospace components). In 2023, for example, China’s auto exports surged 58% to 4.91 million, driven by electric vehicle growth, to overtake Japan (4.42 million) as the world’s top car exporter.¹”

“We anticipate minimal regulatory tightening and incremental support for the private/commodity housing market, aimed at stimulating demand and ensuring the completion of unfinished projects. However, we project another year of contraction, with housing fixed asset investment falling 3%-5% yoy.”

“Deflation will ease due to the base effect of pork and commodity prices. We expect CPI inflation will average around 1%, and PPI inflation around 0% in 2024, due to weak domestic demand and overcapacity.”

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Recovery road map in the Year of the Dragon

Franklin Templeton, Feb 2024

“China’s real estate value chain accounted for as much as 29% of gross domestic product (GDP)² at its peak. There is a clear need for new growth drivers to replace this sector in order to achieve a meaningful recovery and sustain long-term growth in China.”

“New growth drivers we have identified include the electrification of transportation and growth in its supply chain, import substitution of advanced technology hardware, and green energy solutions. Nevertheless, more policy action is required to create additional growth drivers, particularly for household consumption, which at 38% of GDP² remains significantly below emerging market peers.”

“The weak social safety net is often cited as a contributing factor to China’s falling birth rate. State policies to effectively address the structural weaknesses in the provision of health, education and pensions could go some way to incentivizing more people to have children.”

“We are not arguing for the creation of a welfare state, but rather a widening of the social safety net. This could lead to a reduction in precautionary savings, increased employment opportunities in health and social services, and ultimately increased consumption.”

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China’s struggling economy masks a promising investing landscape

AllianceBernstein, Jan, 2024

“Chinese markets suffered because of government efforts to unwind the debt-laden property sector and the resumption of an anti-corruption campaign targeting various sectors. During this economic transition, policymakers were reluctant to provide substantial support for growth, which we view as an attempt to move away from China’s leverage-dependent growth model. As a result, corporate earnings were weak and investor sentiment soured. ”

“China’s property sales continued to tumble in 2023, marking a 54% contraction from the market peak in 2021. And, industries related to the housing market account for about a third of GDP. That said, since we’re more than two years into the economy’s structural slowdown, the base effect of the sector on GDP growth will be milder in the quarters to come.”

Source: CEIC Data, National Bureau of Statistics of China and AllianceBernstein (AB), 30 Nov 2023

“Monetary policy is expected to stay accommodative, which should support Chinese fixed-income assets. China’s monetary policy stance contrasts with much of the developed world, where central banks are keeping interest rates higher for longer than expected to tame inflation. In China, where annual consumer price inflation is running close to 0%, the central bank can afford to ease monetary policy.”

“It’s true that corporate earnings are currently depressed. But that also means there is real potential for an earnings rebound later in 2024, in our view. Earnings of Chinese onshore stocks are expected to grow by 16% this year, compared with 9% for global developed stocks, according to consensus estimates. A potential earnings recovery combined with today’s low valuations creates attractive conditions for investors to initiate positions in Chinese equities.”

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China: Time to revisit an unloved asset class

T. Rowe Price, Dec, 2023

“Despite the muted economic backdrop, investors should focus on finding businesses that can consistently increase their earnings power. These opportunities could be found, for example, in the technology and industrial sectors which leverage the industrial upgrade and green transition. In traditional industries, including shipbuilding, offshore oil service, copper, etc., we expect an improving return on invested capital driven by favourable supply/demand dynamics. ”

“We’d also encourage investors to distinguish the index-level performance from true return potential in Chinese equities. While the MSCI China Index hasn’t done much over the past 10 years, the top 20 A-share stocks with the highest foreign ownership have outperformed the index significantly. China remains a highly inefficient market, with retail investors accounting for around 70% of trading volume. Their average holding period is approximately 16 days. This can lead to high market turnover and ample mispricing opportunities.”

“Another disconnect for Chinese equities is between the opportunity set and investors’ asset allocation. China has over 6,000 stocks, but only around 1% are mega-caps with a market cap of USD 30 billion-plus. However, that 1% of stocks have a weighting of over 50% in the MSCI China Index. Mainstream China funds, on average, put over half of their assets under management into just 1% of stocks. The remaining 98%–99% of the China stock universe is arguably underexplored. We believe there are favourable excess return opportunities beyond the well-discovered large-cap consensus names.”

“With Chinese equities in a third consecutive year of decline, it is a test of investors’ conviction and patience. However, we believe the prolonged downturn provides the opportunity to own some great Chinese businesses at attractive prices. It is often said that the best investment opportunities occur during the most uncomfortable periods. We believe that we are currently in such a period for Chinese equities.”

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Endnotes

1. Source: Japan Automobile Manufacturers Association, China Association of Automobile Manufacturers.
2. Source: CEIC. December, 2021.

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