Is China uninvestable?

Catherine Yeung

Fidelity International

A lot of people are currently debating whether China is indeed uninvestable. At Fidelity, we continue to believe that as an asset class, Chinese equities remains very, very attractive over the longer term, driven primarily by China's contrarian COVID policy, central bank divergence and attractive company valuations. In the article below, we explore these in more detail and outline four reasons investors should be looking at China. 

A zero COVID policy

Now one of the biggest criticisms is, in fact, the COVID policy that China continues to retain and that of a zero COVID policy whilst the rest of the world appears to be opening up. So why has the government done this? Well, it's really about stability. And in fact, many of the senior government officials, not just this year, but last year in previous years, have really focused on stability, both from an economic as well as a social perspective. And so the zero COVID policy we believe is likely to remain in place because we have a very important Congress meeting in October, November this year. It's akin to let's say a presidential election in the US or another leadership election elsewhere around the world.

And so for the stability to continue, or the reason why the stability is important is because if cases continue to erupt or the hospital system would be overwhelmed, then you risk this aspect of social stability. So it's likely to remain in place, although we have seen some tweaks in terms of dynamic COVID policy. With the lockdowns we have seen in China in cities such as Shanghai and Shenzhen, what this means though from a sentiment perspective and an economic perspective is potentially a risk on both consumer demand and spending, as well as exports.

A lot has been priced in

The economic slowdowns we have seen are likely to be transitory. Many countries around the world have come out of lockdowns and seen the pent up demand argument play through. So household savings in China continue to be very attractive. So as we see the restrictions being eased across these various cities, then it's likely this pent up demand will also play out.

In terms of exports, we're closely monitoring disruptions to the supply chain because there's a lack of movement in certain cities that do have these lockdowns. So again, we're expecting that exports could weaken, especially during the month of April and in the second quarter, as you've seen some of these very strict lockdowns emerge.

The macro environment remains optimistic

So China continues to have an economic growth target of five and a half percent. Some argue, again, it's very challenging to meet this target, but we would argue that the economic slowdown is in fact transitory. And one of the reasons why China can also add or boost support into the economy is just like it's COVID policy, it's at the other and the spectrum versus the rest of the world in terms of its monetary and fiscal policy and where it is in the cycle. So as we see the US Federal Reserve and other central banks tighten interest rate, deal with inflationary pressures, China's at the other end of the scale, so as to speak. So since the third quarter last year when we saw the inflexion peak in terms of tightening measures in China, we've since seen the PBOC, or the central bank in China, ease restrictions.

Now, given this big divergence in terms of monetary policy, we don't expect to see any significant cuts to interest rates in China as the US, for example, continues to tighten. Might see some further tweaks in terms of what we call the triple R. So that the Reserve Requirement Ratio. Fiscally, however, the Chinese regulators and policy makers do have a lot of room to move in terms of infrastructure spending. And we've seen this, for example, in the electricity segment, which has grown 24% year on year. We've also seen some leading infrastructure investment in terms of government approval in terms of projects, as well as the issuance of certain bonds in the first quarter. That's government bonds. So expect to see more fiscal stimulus being added in the second half of this year, probably lesser from a monetary perspective, but nonetheless, the PBOC is in a position to add support, unlike other central banks.

Sentiment is bearish on China

And finally, when we look at market dynamics such as price, sentiment and valuations, we have a technical analyst which is part of the investment team, and he's found that historically, a bear market in China tends to last, from a technical perspective that is, for less than a year with an average decline of 47%. So this current correction we've seen has declined by more than 50% from the peak we saw in February 2021. So it's lasted for over 13 months. So this suggests, again, from a technical perspective, that we're in quite a mature sort of duration and magnitude wise correction that we've already seen.

And then there's sentiment. A lot of people seem to be very bearish on China. So the shorting ratio is around 14%, historically that is, average with the current reading at just over 20%. So closer to a four standard deviation event. This is pretty dramatic. 

And so usually as a contrarian indicator when people are this negative, it can often lead to a good time to re-enter the market.

And then finally, I mentioned earlier about all this negative news being priced in. We just have to look at valuations. When we look at China, Hong Kong, the market's trading at low teens in terms of forward P/E. 10th percentile for the past 20 years. So really, this is at the bottom 10%. Whereas the equivalent for the US stock market, the Indian stock market, 19 times, 20 times, both trading at the 90th percentile. So again, China's very, very different in this regard. Valuations on top of the monetary and fiscal policy position that they're in. And of course, a COVID policy that we're still seeing put in place.

A final question that many of our clients have been talking about is if we were to have an exposure to China, what's the best way to do it stylistically? Is it through growth? Is it through value? Especially as we see this rotation towards value continue to play out over the past year, year and a half. In terms of differentiating growth and value sectors or stocks, what our analysts have found is that the upside is very, very similar in terms of aggregate looking at it. So if we look at the growth names, 48% from current levels versus value of 42%. Also, when we look at our analyst forecast, when we look at target prices, we're seeing stocks offering between 30% to 90% upside.

So really at this juncture, if you can stomach some of the volatility, we're likely to continue to see volatility in the market, even though we've spoken about this aim of having stability in China. The long term structural drivers, the negative sentiment, which is almost too bearish at the moment, the valuations, where China stands in terms of the policy cycle and being very differentiated and having the tool set to actually add support into the economy. But we do think that this volatility is transitory and again, the long term case remains very attractive. Thank you.

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Catherine Yeung
Investment Director
Fidelity International

Catherine Yeung is an Investment Director for Fidelity International. Based in Hong Kong, she works within the investment team and with Fidelity’s Equity Portfolio Managers. She is responsible for product management and communication of the firm’s...

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