Navigating China’s policy pivots
Philip Saunders, co-head of multi-asset growth Ninety One: “The reaction functions of Chinese policymakers are changing materially. Since 2020 we have witnessed the roll-out of President Xi Jinping’s longer term policy priorities which had to be in place before this autumn’s 20th Party Congress. A number of these ‘five pivots’ combined to create uncertainty and had a negative impact on Chinese equities in 2021. By contrast, growth, driven by buoyant export demand, remained strong but showed signs of material deceleration in the second half of the year."
The five pivots:
Income/wealth distribution: The push on this front is captured by the phrase “common prosperity for all and more equal wealth distribution”.
Environment: China is pursuing a green agenda and has committed to peak carbon by 2030 and carbon neutrality by 2060.
National security and self-sufficiency: This pivot is aimed at increasing reliance on the domestic cycle of production, distribution and consumption to drive China’s economy, rather than overseas markets and technologies. It is also reflected in the drive for technological independence and energy self-sufficiency.
Curbing financial risks: An aspiration to prevent a major financial foul-up lies behind Beijing’s crackdowns on shadow banking, local-government debt, peer-to-peer lending, cryptocurrencies and property developers’ leverage ratios.
Anti-monopoly and regulation: This pivot has led to crackdowns in areas such as education and the internet.
“While the priorities are set, the pace is not. In late 2021, the authorities’ priority has shifted decisively towards growth stabilisation, so three of the five – common prosperity, curbing financial risks and anti-monopoly measures, are likely to be de-emphasised. By contrast, efforts to boost national self-sufficiency will be sustained and environmental investment is an obvious candidate to be accelerated to support growth.
“Initial moves towards stimulus have been gradual because policymakers want the economy to transition to a new equilibrium, however, property sector weakness and the spread of the Omicron virus is set to undermine growth more materially than expected, requiring a more decisive response by the authorities. Chinese financial markets should respond positively to a more supportive liquidity environment, pre-empting an eventual economic stabilisation.”
Close to home: domestic companies could be well placed
Wenchang Ma, co-portfolio manager, All China Equity, Ninety One: “For equity investors, the shares of select Chinese companies that primarily serve their home market have the potential to perform relatively well next year. First, the macro backdrop looks more favourable. After roaring back from the initial COVID outbreak, the Chinese economy has been through a more difficult spell. A policy of deleveraging led to a reckoning for some highly-geared property developers, while a slower pace of investment growth – combined with power shortages and occasional local COVID lockdowns – induced a sharper slowdown than many had expected. Now, though, the shift by China’s policymakers towards providing more support to the economy, should offer a tailwind for Chinese stocks.
“Within the asset class, focusing on domestically oriented Chinese companies may be a smart way to manage one of the likely big risks of this year – the chance of a flare up of geopolitical tensions, particularly with the US. Should Washington and Beijing get their claws out over trade and national security, home-focused businesses are more likely to be shielded from the heat."
Ma continued, “However, care is needed on valuations. Some Chinese companies are trading on excessive multiples, way ahead of their earnings potential. That said, with improving earnings momentum and market interest widening into a broader array of stocks, against a more positive economic backdrop, there should be good opportunities. Picking stocks using a bottom-up approach can help uncover investment ideas across the wide spectrum of industries that China’s dynamic economy has to offer."
Some tiger-ish confidence may be in order
Charlie Dutton, portfolio manager, Asia-Pacific franchise, Ninety One: “Confidence is one of the notable characteristics of people born in Tiger years, and investors in China’s technology sectors and other areas should be feeling more of it in 2022. Regulatory crackdowns on technology, education and other industries have tested the nerves of even the staunchest investors in the past 12 months. But as the dust settles, it is becoming possible to assess the economic impacts of the new rules.
“Within China-tech specifically, we now have some clarity on the actual economic impact of the new regulation. In my view, it was the speed of implementation of regulation, coupled with uncertainty about where it would stop, that most unsettled investors. Looking at the sector now, investors are in a better position than during the crackdown, since they know more about the environment these companies will be operating in, which affords greater certainty on the strengths and limitations of business models.
“As near-term regulatory noise fades, the long-term drivers of structural growth come back into focus. These trends – among them, rising wealth, and the expansion of the middle class; digitisation; and China’s push for self-reliance in certain tech sectors – remain intact, and hence continue to be tailwinds for select Chinese firms. As a quality focused equity investor, strong Chinese companies continue to emerge within healthcare, IT and consumer areas in particular. The overall poor sentiment towards Chinese equities in 2021 sparked a general de-risking by global investors towards China. This has created opportunities within some stocks for confident tigers to pounce on."
On the hunt for over-sold corporate debt
In fixed income markets, recent turmoil has opened potential entry points for investors in developing-world corporate bonds. Alan Siow, co-portfolio manager, All China Bond, Ninety One: “There are notable opportunities in bonds issued by Chinese businesses, as policy-tightening concerns last year sparked a broad sell-off – regardless of individual companies’ fundamental strength – while fears of a recession seem overblown and policy loosening looks set to mitigate macro headwinds.
“The most pronounced mispricing is in China’s real estate sector, and potential to capture alpha both from overweight exposure to the area overall and from positioning within it. We are also looking to capture widespread mispricing opportunities arising from the contagion to other sectors in China, particularly among higher-rated bonds.
“Looking at the emerging market corporate bond universe more broadly, many companies have entered 2022 on solid foundations, with high margins and strong earnings growth as they have recovered from the COVID disruptions of 2021. Company balance sheets are generally in good shape to weather headwinds, as the uncertain outlook last year dampened companies’ appetite for capital expenditure and expansion – which has also been reflected in positive rating actions. Coupled with low average default rates, the result is that emerging market corporate bonds remain a compelling asset class in 2022."
Opportunities for bond investors with the apex creditor
Wilfred Wee, portfolio manager, All China Bond, Ninety One: “China is the largest official creditor in the world – the apex creditor, one might say – and its bond market behaves more like those of developed nations rather than the developing world. But that does not mean it moves in lockstep with the former. Far from it.
“China’s economy will pursue an independent path this year. Its relatively stable growth and inflation outlook sets China apart from the economies of other investment-grade bond markets, where the risk of rate hikes is greater. That’s one reason why, despite the property market correction, China’s government bonds stayed reasonably well anchored. At current valuations, China’s US$700 billion offshore US dollar bond market has a chance of outperforming.
“Meanwhile, China’s US$20 trillion onshore CNY-denominated bond market should remain particularly independent of other asset classes, offering diversification potential to international investors. Near term, the recent volatility among high-yield onshore bonds has created some attractively valued bottom-up opportunities for the discerning investor.
“From a longer-term perspective, the ‘mainstreaming’ of China’s bond market – i.e. its increasing inclusion into major indices and the allocations of large international investors – shows no sign of reversing, providing another tailwind for the asset class."