China: Will the dragon roar in 2024?

The dragon is one of the most auspicious symbols among the twelve animals in the Chinese zodiac calendar, embodying strength, wisdom, luck, and prosperity. As it takes centre stage this Spring Festival, many investors in the region must be hoping that the good fortunes associated with the dragon will translate into better returns in the Chinese equity market after a poor 2023.

It was among one of the worst-performing major markets in the world and investor confidence is languishing near the bottom following three consecutive years of decline.

The year had started with China rolling back its strict zero-Covid measures that had created a lot of uncertainties as local authorities could simply shut down large swathes of major cities, such as Shanghai, at short notice to combat Covid outbreaks. Not only did it disrupt daily life, but it also brought commerce to a grinding halt as stores were forced to shut. Removal of such policies set prompt expectations for a sharp turnaround in the economy, mirroring the path to recovery in the US. However, the market failed to consider the lack of direct stimulus handouts to consumers in China as being a potential impediment.

Initially, the reopening sparked a temporary surge in market optimism, fuelled by hopes for a robust V-shaped rebound in domestic consumption. By April, it became evident that consumers were holding onto their excess savings and delaying significant purchases until their income and employment prospects improved. Nervousness and malaise were also evident in the property market, which contributes a relatively large percentage to GDP, as home sales slowed.

Fundamentals ignored, ‘hot themes’ in fashion

Chinese equities took a hard beating for the rest of the year as a result. Foreign investors pulled capital to search for better returns outside the country, while domestic investors, who account for 90% of the market, chased short-term returns via ‘hot themes’ that were in vogue – specifically around artificial intelligence and state-owned enterprise reforms.

While there are some genuine reasons for concern, such as the untenable debt levels amongst many real estate developers, a disconnect has emerged between market sentiment. This is indicated by current valuation levels and headlines in the press versus the reality of what we are seeing reality on the ground. Chinese onshore names today are trading at historically low valuations, making China one of the cheapest major stock markets in the world. On the other hand, recent activity data have been signalling that the beleaguered economy has found a firmer footing. Both consumption and manufacturing indicators were showing signs of improvement towards the end of 2023. More recently, the Caixin manufacturing factory activity data recorded the third consecutive month of expansion (PMI >50), signifying continued improvement in the sector despite lingering uncertainties.

Of course, cheap valuation alone is not enough to mount a sustainable recovery in the stock market. Earnings growth is also critical. This is where the disconnect is apparent – between a company’s fundamentals and its share price. The last three years have presented Chinese companies with incredible challenges: weak demand, operational issues, and widespread uncertainties. Despite this, many high-quality names have delivered resilient earnings. For example, Aier Eye Hospital’s share price fell 34% in 2023, but its expected revenue and adjusted earnings per share (EPS) change for 2024 are in an upward trajectory[1]. We still expect high single-digit earnings growth for the overall market this year as the benefits of monetary and fiscal stimulus take hold. Our predications are higher for abrdn’s portfolio holdings as these are high-quality companies with excellent underlying fundamentals that are not at all reflected in their share prices.

We have identified three factors at the macro level that we expect would likely drive consumer and investor confidence in China this year:

Pace of recovery

So far, consumers have set the pace for recovery and any changes to this will be influenced by how their income and employment prospects measure up in 2024. There is an inventory re-stocking cycle underway, albeit with a few bumps and knocks along the way, which could push companies to hire more people or offer better compensation to existing employees. Retail sales have also increased month on month while the high savings rate is showing signs of returning to pre-Covid levels as a semblance of normalcy has been restored. The market is estimating consumption spending to pick up this year.

Policy environment

The central government has been reluctant to use large, direct fiscal stimulus to spur consumption for several reasons including the need to maintain a stable renminbi in the face of a strong US dollar and to avoid creating bubbles in the economy. That said, the government has implemented over numerous smaller scale, but crucial measures whose cumulative effects should not be overlooked. There have been over a dozen measures, for example, to support the property market, and ten aimed at helping consumption. If needed, the central government still has the leg room to add additional fiscal stimulus. We expect ongoing or increasing support to restore confidence and support activity as the Chinese economy completes a rebalancing towards consumption and value-added manufacturing.

Property

For confidence in the broader economy to return in a sustainable manner, stabilisation of the property market is vital, and this is where we anticipate the biggest challenges for the authorities. Rising house prices will give consumers the confidence to spend more of the record-high savings they accumulated during Covid. Measures such as easier mortgage access are still working their way through the sector. China has also launched a major urban renewal plan, similar to the redevelopment of shanty towns in 2016 and 2017. In short, the government plans to give homeowners compensation to leave their homes for renovation. Other significant policy steps were only taken in December – such as the lowering of downpayment ratios in Tier 1 cities. So far, these measures have had marginal impact on the sector, but with time, we expect to see a turnaround come through as there remains vast pent-up demand for houses, particularly in the bigger cities.

Overall, we remain optimistic that Chinese consumers would eventually start spending their savings – through consumption and by investing again in the markets. As bottom-up stock pickers, we have identified five sectors that we believe offer good opportunities:

Aspiration: Growing middle class consumers continue to trade up in areas including cosmetics, travel, food, and beverage.
Digital: Growing integration amid the widespread adoption of technology means a bright future for plays in e-commerce, cybersecurity, and data centres supporting cloud services.
Going Green: Policymakers globally are committing to a greener and lower carbon world, and China is in the driver’s seat as investments in renewable energy, batteries, electric vehicles, related infrastructure, and environment management all have a bright future.
Health: Growing baby boomers are driving demand for healthcare products and services.
Wealth: Structural growth for consumer finance and increasing asset allocation to capital markets amidst declining property sector.

Companies selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance.

[1] Bloomberg, January 2024