China will offer investors a rare source of strong growth potential in 2023 with a number of nations on the precipice of recession following crucial mistakes by global policymakers.
In 2020, authorities in advanced economies introduced the most extraordinary stimulus measures in decades to prevent the shock of the Covid-19 pandemic developing into a fully blown financial crisis.
But according to abrdn’s Research Institute, they left these monetary and fiscal stimuli in place for far too long, creating the inflation problems that many central banks are dealing with today.
Core inflation in the US was running at 6% even before Russia invaded Ukraine and inflated energy prices further, our institute notes. Now the question is the degree of damage policymakers need to inflict on the global economy to solve the imbalances they created.
Our institute is forecasting a deeper global recession than consensus. While global inflation has now likely peaked, wage growth remains elevated in advanced and some emerging economies.
The need for tightness in labour markets to dissipate, allied to already-elevated energy prices and existing disruption to supply chains, means we don’t expect central banks to loosen policy anytime soon. Continuation of that cycle will likely lead to recessions in many economies by mid this year.
In contrast, inflation remains benign in China, enabling authorities to loosen monetary and fiscal polices to support economic growth. It underlines China’s de-synchronous cycle: with economies in much of the rest of the world set to slow down, we expect sequential growth in China to pick up.
However, the road ahead for investors in China could be bumpy at first. Authorities abandoned their zero-Covid strategy abruptly late last year and evidently were not fully prepared to move to endemic living – given low vaccination rates among the elderly and limited capacity of the hospital system.
The removal of Covid restrictions has seen infection rates spiral, and China could endure more than a million Covid-related deaths. Thus far there is no sign of the government introducing measures to flatten the infection rate, implying the Covid wave could be exceptionally high, but break quickly.
Our team on the ground has confirmed the healthcare system is under pressure, but says it has not collapsed and peak pressure appears to have passed in many major cities. We have also noted a rise in subway travel in tier 1 cities such as Beijing and Guangzhou.
“We expect to see a rapid resurgence in household consumption given the level of pent-up demand from China’s years-long zero-Covid strategy.”
While China’s re-opening phase is likely to be bumpy, December’s economic data was better than expected and we could already be passing the peak economic impact.
Looking ahead, we expect to see a rapid resurgence in household consumption given the level of pent-up demand from China’s years-long zero-Covid strategy. Certainly the relaxation of restrictions has unlocked fresh spending in other economies.
In terms of risks to growth, authorities will need to manage deleveraging in the property sector. We give credit to the government for trying to tackle unsustainable debt levels. Unfortunately, efforts to deleverage privately owned developers has negatively impacted demand. Perversely, the fall in prices has discouraged people from buying property.
It’s why we expect authorities to announce stimuli at the annual Two Sessions of China’s National People’s Congress and National Committee of the Chinese People’s Political Consultative Conference in Beijing this March. This could include reducing home down-payments or loosening restrictions on buying second homes to support demand in the sector.
Another fear for investors is regulatory intervention in sectors such as technology. But news that billionaire Jack Ma is to relinquish control of fintech firm Ant Group could be a game-changer – potentially clearing the way for Ant Financial to list. We think that would be an important signal to the market of a reduction in regulatory uncertainty.
Ultimately, we would highlight four key reasons for investors to consider an allocation to Chinese equities now – not least because the market has been so depressed until the past few months that any pick-up in sentiment will likely help it spring back like a rubber band.
Firstly, China is on the opposite side of the economic cycle to many developed markets, with benign inflation enabling Chinese policymakers to retain an accommodative monetary and fiscal stance. That will help to drive growth even as we expect much of the rest of the world to be in recession.
Secondly, valuations are appealing. China’s A-share market is trading at around a 35% discount to its 15-year average on a price-book basis1. Importantly, a number of firms that we own still saw earnings growth of close to 20% last year despite macro-economic headwinds, and our forecast resurgence in domestic Chinese consumption this year would be supportive for company revenues.
Thirdly, Chinese equities enjoy low correlation with global equities. China’s A-share market has just a 26% correlation to the MSCI World Index2. In other words, an allocation to Chinese stocks could offer diversification benefits at a time when advanced economies are locked in a policy-tightening cycle.
Fourthly, the Chinese government is committed to fostering a culture of innovation to drive economic growth. In this it has an advantage as it produces a higher number of Science, Technology, Engineering and Maths (STEM) graduates due to the sheer size of its population. Already it has a large global market share in the manufacture and production of solar, battery and wind power.
We favour five investment themes that we’re confident the government will support in line with its priorities to become more reliant on domestic consumption and self-sufficient in hardware, software and semi-conductors to facilitate competitiveness in an era of strategic rivalry with the US.
Aspiration: rising middle-class wealth will drive demand for premium goods and services.
Digital: aligned with improving productivity and lowering costs to drive innovation and growth.
Green: China dominates global manufacturing capacity for renewable energy and storage.
Healthcare: there’s a need to make healthcare accessible given China’s rapidly aging society.
Wealth management: aligned with aim of becoming a moderately prosperous society by 2035.
1 Source: abrdn, 8 December 2022
2 Source: abrdn, September 2022