Is a re-opened China a danger or an opportunity?

Tim Richardson

Pengana Capital Group

Consumer spending accelerated when China suddenly abandoned its zero-Covid policy, but the country’s longer-term challenges remain. Global investors have some dangers to manage and opportunities to examine.

When written in Chinese, the word ‘crisis’ is composed of two characters. One represents danger and the other represents opportunity.”
President John F Kennedy

All change in China

China has just sprung three surprises on investors which have been received positively.

  • In early December China’s government suddenly announced it would abandon its zero-Covid policy; most controls have been lifted, allowing people to socialise freely and travel again
  • It appears to be quietly unwinding measures that aimed to constrain sectors it felt did not align with the values of the ruling Chinese Communist Party, including technology, real estate, and private education.
  • China seems to be moderating its aggressive and coercive ‘wolf warrior’ diplomacy, aiming to reduce trade tensions with the west

These moves aim to re-accelerate China’s economic growth which has been impacted by rolling Covid lockdowns, unpredictable regulatory change, and US export controls.

Covid infections and hospitalisations in China soared when controls were lifted, but it appears that most employees have now been infected, recovered, and returned to work.

This presents investors with some interesting near-term opportunities, but they should recognise the longer-term challenges facing China.

Where are the opportunities in China?

The macro-economic environment appears attractive with low inflation and some slack in the labour market that will support the economy – which is officially targeted to grow at ‘around 5.0%’ in 2023. China also has scope to cut interest rates, which are currently 3.65%.

China’s return to rational policymaking should bring a more business-friendly environment. The government is now focussing on stimulating the consumer sector to rebalance an economy that largely grew on lower value manufacturing and property development. Consumer businesses are expected to see the greatest benefit as restrictions on movement ease.

Consumer technology groups such as the search engine Baidu and online retailer are well positioned as people re-connect and those sidelined by lockdowns secure work. The return to normal housing market activity as apartment-viewing re-starts will support property service providers such as Country Garden Services Holdings. Insurance groups such as Hong Kong-based AIA Group whose complex life and medical policies require face-to-face consultations should grow sales.

Global brands with a strong presence in China can increase earnings as the country returns to socialising and mall shopping. These include Estee Lauder, Nike, and Kering (owner of Gucci).

China’s government is backing away from aggressive oversight of large technology groups, having previously levied massive fines, investigated data abuses, and tried to limit children’s gaming hours. Its announcement that it will support digital companies to “fully display their capabilities” will benefit large tech groups such as Tencent.

China’s improved cooperation with US audit regulators makes it less likely that dual-listed Chinese stocks will be de-listed in the US. Reduced trade tensions will also be positive for pharmaceutical companies such as Wuxi Apptec, which depends on exports to the US for 53% of its revenues.

Global semiconductor developers such as NVIDIA and Advanced Micro Devices can benefit if they are able to navigate the US-China trade relationship. Opportunities may come from China’s shift up the value chain from e-commerce, gaming, and social media to artificial intelligence and machine learning.

But beware longer-term risks!

Despite the brighter near-term picture, China’s long-term outlook remains challenged. Beijing alienated international investors with poor policy choices that arbitrarily caused harm. China further suffers from very challenging demographics, aggravated by a weak public health service.

Investors in China face four significant risks:

  • Beijing is currently focussed on re-energising the economy, but sudden changes to policy or regulation could harm shareholders
  • New COVID variants would carry risk given China’s weak public health service and low vaccination rate among the elderly
  • The US is resisting China’s attempts to draw level in super-computing using export controls; tension over flashpoints such as Taiwan has eased somewhat but may flare up suddenly
  • ESG issues such as modern slavery, corporate governance, and carbon emissions could impact investor returns and should be actively managed

Where does this leave investors?

China’s business climate has recently improved. Companies exposed to consumption growth in China have the opportunity to boost earnings. Global brands established in China are well placed to access their consumers. However, Chinese businesses dependent on sensitive western technologies should be approached with caution.

Tim Richardson
Investment Specialist
Pengana Capital Group
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