China investors are still in recovery following unprecedented government crackdowns on a number of key industries – internet, private education and real estate. Concerns over zero-Covid policy, geopolitics and domestic policy uncertainty also loom large. These factors combined raise the question: “Is China still investible?”
While many of these risks warrant close monitoring and require delicate calibration when investing, we think that they are still some distance away from being deal-breakers for equity investors. Indeed, perhaps the question should be: “Can you afford to miss out on the opportunities presented by the world’s second-largest economy?”
Exhibit 1. MSCI China 12-month forward P/E ratio – 2016 to present
Source: MSCI, Refinitiv, Eikon, J.P. Morgan. Data as of 27 May 2022
Addressing the issues
Zero-Covid
- Recent data shows that nationwide lockdown areas are getting less ‘still’ and economic activities are gradually recovering.
- On the demand side, we expect to see some pent-up demand in the second half of 2022, albeit they might not be as strong as in 2020.
- On the supply-side, while near-term Covid-related supply chain disruptions should be solvable, long-term confidence regarding supply-chain safety in China is being tested.
- The contrarian view may be that the worst is already priced in for China equity and markets have bottomed out. Beijing is releasing more economic stimuli while central banks across the rest of the world are tightening fiscal and monetary policies.
Geopolitics & deglobalisation
- Geopolitics is an increasingly important consideration. Focus originally centred on the US trade imbalance, but Russia’s invasion of Ukraine made it even clearer that the world may be de-globalising or forming blocs.
- Global supply chains breaking up will be a big change for China’s manufacturing landscape, but it doesn’t make China un-investible – it has been relying on its domestic economy/consumption-led growth model for several years.
- Some fear whether Russian-style sanction risk could be applied to China, but Chinese leadership is historically more conservative and economy-driven than Russia. China’s economy is also more than 7x that of Russia’s and is a major partner to the global economy.
Exhibit 2. China: a truly global trade partner with USD2.6tn in exports (top) and USD1.6tn in imports (bottom)
Source: The Observatory of Economic Complexity (OEC). Data shows 2019 calendar year.
Government-led growth model
- Does Beijing’s heavy hand in the economy make it un-investible? History tells us the government has been effective at delivering economic growth over the past two decades.
- The long-term priority remains intact; with GDP per capita only USD10,000, China is still very much focused on economic growth, much like the Four Asian Tigers (1960-90).
Outlook
Global markets are volatile and challenging. Central banks will continue to drive key inflation and economic growth and volatility are likely to remain high. Big disruptive changes are seen in China and the global economy, but we see these as multi-year investment themes to study. Chinese equities provide diversification, idiosyncratic alpha and thematic long-term growth potential.
Chinese equity markets are down 18% year-to-date and MSCI China valuations are down from 18.4x in February 2021 to 9.9x PER in June*. We believe the near-term risk/reward proposition is looking attractive. Now could present a good opportunity to slowly start building China exposure.
To learn about the long-term drivers of China’s equity market, see ‘Why GDP doesn’t drive Chinese Equity returns’.