The Chinese Market: Sparks or Scorches?

As China enters a new year it is fitting to draw a comparison with this year’s zodiac animal, the dragon. Undoubtedly, the Chinese economy could do with a bit of luck and strength, attributes associated with the dragon. However, the key question remains: will the market heat up or will investors just get burnt?

Rewind one year and investors were projecting a strong recovery in China given a long-awaited farewell to its zero-Covid policy. This optimism was short lived. The rally in China’s stock market quickly tailed off as structural problems became alarmingly apparent. Deep-seated problems in the property sector, with defaults by major developers led by property giant Evergrande, had a knock-on effect on domestic lenders. FDI flows, domestic manufacturing, exports and consumer spending all remained weak, exacerbating China’s deflationary cycle. Such issues left Chinese equities trading at record lows.

However, a closer look at key metrics could indicate a disconnect between market sentiment and the reality on the ground. Box office sales increased in 2023, domestic tourism is booming with planned travel expenditures for 2024 surpassing 2019 figures, and car sales are reaching unprecedented highs. These are all important signals for a potential rebound in consumer spending this year.

Furthermore, the Chinese government has initiated measures to strengthen domestic demand, support the stock market and shift away from an over-reliance on infrastructure and real estate investment. A recent measure by Beijing to mitigate selloffs in the market and promote stability comes in the form of increased purchases of onshore Chinese stock market ETFs by state and sovereign wealth funds.

While measures so far have fallen short of substantial fiscal interventions many investors hoped for, the cumulative impact of the government's smaller-scale initiatives should not be ignored. Furthermore, China's upcoming National People's Congress (NPC) session on 4-5 March is a key annual meeting where economic and social development plans for the year will be unveiled. Analysts expect a GDP growth target of 5% and the announcement of further measures to boost growth, support demand and improve the business environment.

So, given China’s attractive valuations, improving consumer sentiment and increasing fiscal support, why do we continue to invest cautiously in China?

First of all, despite some positive signs, structural challenges remain. 70% of household wealth is tied up in property, and the crisis is by no means over. Property investment and new construction dropped 9.6% and 20.4% respectively in 2023¹. Furthermore, Evergrande’s liquidation order in January and the liquidation petition filed against Country Garden on 28^th February are exacerbating the lack of confidence in the property sector. This may lead to an extended period of cautious consumer spending.

Additionally, the CCP's intervention in the economy, coupled with lower corporate governance standards among Chinese companies compared to their Asian EM counterparts, continue to steer us away from direct investment in China. The CCP’s near destruction of the EdTech sector in 2021 is a prime example of the regulatory risks inherent in the country.

Finally, when it comes to companies, we rarely find the level of governance, fundamental quality and innovation that would meet our investment criteria. Instead, we prefer to access the Chinese market indirectly through countries such as Taiwan and South Korea which also benefit from improving consumer sentiment in China. For example, our portfolio includes Elite Material, a Taiwanese company specialising in components for the semiconductor industry. It operates manufacturing facilities across China and generates a significant proportion of its revenues in the country while offering Taiwanese standards of governance and transparency.

No investor can afford to ignore the world's second largest economy and China is still forecast to grow by 4.6% in 2024², much faster than any developed market economy and many of its emerging market peers. So, we continue to scour the Chinese market for exciting companies that meet our quality investment criteria.  

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¹ National Bureau of Statistics of China

² IMF World Economic Outlook Growth Projections, January 2024

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