Entering the dragon’s lair: The strategic case for investing in Chinese equities

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The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. The views expressed in this document should not be taken as a recommendation, advice or forecast. Past performance is not a guide to future performance. We are unable to give financial advice. If you are unsure about the suitability of your investment, speak to your financial adviser.

Over the past year, Chinese equities have continued their struggle, echoing the global sentiment dampened by the US Federal Reserve's interest rate hikes and a strong dollar. However, looking beyond the immediate challenges reveals a landscape ripe with opportunity for the discerning investor.

The downturn in Chinese equities has been marked, with both the Hang Seng and MSCI China indices reflecting significant drops in their US dollar returns. This decline, fuelled by a combination of rising risk premia and concerns over China's economic growth and property sector woes, has resulted in valuation levels not seen since the onset of the COVID-19 pandemic. 

A constructive outlook

Despite the pervasive pessimism, there are compelling reasons to maintain a positive outlook on Chinese equities. The current sell-off, driven by short-term uncertainties and fears of recession, may be obscuring the longer-term prospects of companies positioned to benefit from structural tailwinds or those holding strong competitive advantages. 

Moreover, an uptick in shareholder value-enhancing activities, such as accelerated share buybacks and disciplined corporate actions, indicates a proactive approach to capital management among Chinese listed companies.

Macro and micro drivers

China's macroeconomic setting provides a conducive backdrop for growth in our opinion, characterized by low inflation, easing policy restrictions, and a substantial current account surplus. The relatively weak yuan further enhances China's competitive positioning, especially once demand from Western markets rebounds. This combination of low interest rates, low inflation, and a competitive currency generally bodes well for financial assets.

Supportive measures from the Chinese authorities, including easing reserve requirements and cutting mortgage rates, alongside pledges to inject long-term funding into the money markets, signal a robust policy response aimed at stabilizing market confidence and mitigating the impact of a slowing real estate sector.

In search for opportunities

While energy transition is a significant area of opportunity, and one that we have discussed previously, the Chinese economy's multifaceted nature offers a wealth of opportunities across various sectors. Each of these sectors not only contributes to China's global economic stature but also presents unique investment prospects in our view.

Technology and Innovation

The technology sector in China is a powerhouse of innovation, driving forward advancements in 5G, artificial intelligence (AI), and semiconductor manufacturing. Despite facing regulatory scrutiny, tech companies continue to be at the forefront of China's economic evolution, offering products and services that are integral to both domestic and global markets.

Consumer Dynamics

The consumer sector stands out for its dynamic growth, fueled by an expanding middle class and increasing digital penetration. Opportunities abound in e-commerce, premium consumer goods, and health and wellness products, catering to a more affluent and health-conscious consumer base.

Financial Services

China's financial sector is undergoing significant transformation, with fintech innovation leading the charge. The adoption of digital payments, online banking, and wealth management services points to a shift towards a more inclusive and technologically advanced financial ecosystem.

Real Estate and Infrastructure

Despite the challenges facing the real estate sector, infrastructure development remains a priority for China. The focus on sustainable and smart cities, along with the Belt and Road Initiative, underscores the long-term investment potential in construction, engineering, and related services.

Manufacturing and Export

As the “world's factory”, China's manufacturing sector is diversifying into higher-value goods and services. The Chinese government's emphasis on “Made in China 2025” aims to enhance manufacturing capabilities in high-tech industries, reinforcing China's role in the global supply chain.

Regional Synergies

The ripple effect of China’s economic rebound also extends across the region, notably benefiting companies in Japan and Taiwan—two economies intricately linked to China's industrial engine. In particular, companies within the semiconductor, heavy machinery, and construction material sectors in these nations have experienced the ebb and flow of China's economic tide. As China's pace of growth has decelerated, these sectors have faced earnings pressures; however, there is a silver lining as the tide may begin to turn.

Recent Purchasing Managers’ Index (PMI) data echo a more positive sentiment, resonating with commentary from firms in Japan and Taiwan that have substantial exposure to the Chinese market. This may indicate that the nadir of the cycle may well be behind us. As China positions itself for a resurgence, these sectors are likely to witness a corresponding uplift. Importantly, the anticipated recovery need not hit the previous peaks in earnings to be impactful. Given the current attractive valuations, we believe even a modest uptick in earnings could render many of these stocks a compelling proposition for investors looking to leverage the broader Asian economic restoration.

The path forward

Investing in Chinese equities, in light of the current climate, necessitates a nuanced approach. Investors looking to tap into these opportunities should consider companies that demonstrate innovation, market leadership, and the ability to adapt to changing regulatory landscapes. This strategy not only mitigates the inherent risks of the market but also positions investors to capitalize on the rebound and growth potential. With the Chinese government's support for high-tech and sustainable industries, focusing on companies that align with these policy directions could yield substantial returns.

Moreover, diversification across sectors and a focus on long-term value rather than short-term fluctuations can serve as a hedge against volatility. Engaging with companies that demonstrate clear growth trajectories, strong balance sheets, and the capacity to navigate regulatory landscapes will be key to unlocking value in this market in our opinion.

In conclusion, while the immediate outlook for Chinese equities might appear challenging, the undercurrents of opportunity are palpable for those willing to look beyond the surface. The combination of favourable macroeconomic conditions, policy support, and untapped sectoral potentials provides a compelling case for investment. As always, a disciplined, informed, and strategic approach will be essential in navigating the complexities of the Chinese equity market and harnessing its potential for robust returns. Amidst the volatility and uncertainty, the Chinese market, with its breadth and depth, continues to offer a wide spectrum of opportunities for the engaged, bottom-up investor.

 

* This article was first published, in Chinese, in the Hong Kong Economic Journal.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. The views expressed in this document should not be taken as a recommendation, advice or forecast. Past performance is not a guide to future performance. We are unable to give financial advice. If you are unsure about the suitability of your investment, speak to your financial adviser.

The content of this page reflects M&G’s present opinions reflecting current market conditions. They are subject to change without notice and involve a number of assumptions which may not prove valid. All information included in this page has been written for informational and educational purposes only and does not constitute an offer or solicitation to invest into any security, strategy or investment product. Information given in this document has been obtained from, or based upon, sources believed by us to be reliable and accurate although M&G does not accept liability for the accuracy of the contents.