A turning point in one of the world's most closely watched markets

China has been one of the most discussed topics during our meetings with clients and investors over the past few years. And it’s easy to understand why.

The region has been one of the most hotly debated in global markets and exposure has been uncomfortable.

The economic slowdown persisted longer than we expected due to the Ruling Party’s COVID-zero policy, which compounded troubles in the property sector. And just last month President Xi’s consolidation of power (forming a Politburo consisting of supporters) roiled markets, and certain high profile US institutional investors announced plans to cut exposure.

This was arguably a point of peak fear. The market was not factoring in a top-down resolve to exit COVID-zero, policy change (despite PBoC loosening) or the potential for more supportive policy.

But now, the tide could be turning. 

China’s ruling Party’s stance has meaningfully shifted in the last week or so; support for property developers and home buyers is increasing, and policies around COVID-zero are relaxing.

We discuss each of these factors below.

  

The property sector policy pivot  

The government-backed bond financing programme – where the government guarantees bonds raised by property developers – has been expanded in size and is accessible to more developers, debt that is maturing can be rolled for up to one year, caps placed on bank lending to the property sector are being removed, and property developers are allowed to access funds from presales.

This is in addition to the People’s Bank of China (PBoC) injecting capital directly into several state-owned banks for property and infrastructure lending i.e. the PBoC’s version of QE.

Even with this support we still expect primary sales to drop below trend demand of around 12m units p.a. to work off the excesses from the 14 – 15m p.a. units sold over the last five years.

The shift in COVID-zero

On top of this, China is relaxing its COVID-zero policies. While there has been a push to increase vaccinations, there has been a change in the rhetoric around the severity of the virus – which indicates a move towards living with COVID. There’s been greater tolerance for case counts before citywide lockdowns, PCR testing requirements are being reduced, and the definition of a close contact has been loosened. 

This is all the while case counts are at a very elevated level and rising.

As we’ve said previously, China isn’t going to have a 'big bang' reopening like the developed world, but will continue to ebb and flow along a path towards normalisation.

And as lockdowns continue to ease, rising money supply will be felt more broadly through the economy.

The PBoC has been loosening as the rest of the world is tightening. Money supply in China has been accelerating at the fastest pace in five years at 12% yoy and the credit impulse (the change in credit relative to the change in GDP) has recently turned positive.

Even after recent moves, Chinese equities listed locally and abroad are still priced at 12x 12-month forward earnings. Sentiment is worst amongst foreign investors. Chinese companies with a primary listing in HK or US are trading at just 8x forward earnings which, on a cyclically adjusted PE basis are priced at a c. 60% discount to the world – a 20 year low (figure 1). But while foreigners have been selling, Chinese investors have been buying; net southbound investment into Hong Kong is at the highest levels in the last 18 months.

Current valuations are attractive given evidence that policy is shifting away from reform to economic health, even if geopolitical issues result in a structurally lower growth rate and a higher discount rate.

The main risk lies in geopolitics

Midea Group is a leading manufacturer of air-conditioning units and white goods which has been a market share taker in domestic and export markets due to cost control, more attractive pricing, and a strong distribution network. 

In a normalised environment we see the company growing revenue and earnings c. 10% p.a. from a replacement cycle which sees households upgrade to higher energy efficient products at higher price points, continued market share gains due to the company’s investment in distribution, and development of its international and B2B businesses. 

Weak housing starts and a soft economy has seen Midea’s valuation fall to 10x forward earnings - an attractive multiple for a resilient business that has consistently delivered an ROE of mid-20% over the last decade and will be a beneficiary of stabilisation in the property sector, improvement in consumer confidence, and arguably any stimulus directed at durable goods consumption.  

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