Has the Chinese dragon finally awoken?

3 min read 16 May 24

The global equity markets were clearly in correction mode in April, with one major exception: China. After a rather disappointing first quarter, the Chinese equity market posted double-digit gains in a relatively short period of time, not only catching up with the MSCI All Country World Index in the current year, but even overtaking it. The performance of the Hang Seng China Enterprises Index, which consists of Chinese companies listed in Hong Kong (the so-called "China H-Shares"), is +16.8% YTD (in euros, as of 6 May 2024). By comparison, the performance of the two highly praised US indices NASDAQ Composite and S&P 500 is "only" +11.8% (also in euros) over the same period.

Past performance is not a guide to future performance.

Despite this exceptional catch up, investors who have been invested in China for some time are unlikely to be jumping for joy. This is because the Chinese equity market still lags far behind the global equity market over longer time periods. While the MSCI All Country World Index has gained 31% over the last three years, the Hang Seng China Enterprises Index has lost 25% (in euros, as of 6 May 2024). The gap – or to put it positively, the catch-up potential – is therefore still enormous. But what is the reason for the weak longer-term performance?

Macroeconomic reasons are only one part of the truth 

The long-term macroeconomic outlook for China has undoubtedly deteriorated in recent years. The population in China is now shrinking, debt is increasing at a rapid pace and the artificially inflated property sector is in the midst of a downturn that is likely to slow down Chinese economic growth for some time to come. Added to this is an insecure population which, despite its savings, is not yet willing to consume to the extent that would be necessary to give the economy a noticeable boost. Hovering over all of this is the risk of geopolitical tensions - particularly between China and the US – which could be fought over a trade war or, in the worst case, even militarily.

But these negative factors are only one part of the truth. The whole truth also includes the fact that companies in China have disappointed their shareholders over many years and thus lost a great deal of trust. The strong economic growth of the last decade, which was probably the main reason for many investors to invest in China, has not been reflected in a corresponding rise in corporate profits. Regaining this confidence will be one of the major tasks for Chinese companies in the coming years.  

The current situation is not as negative as it seems

But there are also some bright spots. Looking at leading indicators such as the purchasing managers' indices (PMIs), for example, they do not seem to confirm the negative sentiment regarding the Chinese economy. Although the PMIs are not signalling a massive economic boom, they are at least in expansionary territory, which points to a positive development. From this perspective, things are looking better for China than in Europe, for example.

Past performance is not a guide to future performance.

Companies are trying to regain trust

In the past, the ability of companies to translate China's high economic growth into rising profits clearly left much to be desired. However, a rethink is clearly taking place. For example, a rapid rise in dividend payout ratios and increasing share buybacks can be observed – both can be seen as an indication of increasing shareholder alignment. In addition, more and more companies are focussing on increasing profitability. These could be ongoing improvements in the Chinese equity market landscape, which could lead to solid returns for investors despite the expected lower economic growth. 

Valuations are pricing in an extremely pessimistic scenario for China

Although the risks cannot be dismissed, it is worth questioning how much of these negative aspects are already priced into current share prices. If you look at the valuations of Chinese equities, the answer is clearly "quite a lot". Valuations are close to their historic lows and around 40% below the average of the past 20 years. The potential for positive surprises is therefore enormous. Negative news from China in the coming months, there could still be enough room for further price gains despite the strong performance of recent weeks. It could therefore be worth taking a look at the Chinese equities.

Past performance is not a guide to future performance.

The value of the fund's assets will go down as well as up. This will cause the value of your investment to fall as well as rise and you may get back less than you originally invested. The views expressed in this document should not be taken as a recommendation, advice or forecast.

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