What we cover:

  • Key takeaways from the 20th Party Congress
  • Where next for the economy?
  • Where next for equites?
  • Where next for fixed income?

It’s been a difficult year for investors in China. The country’s ‘zero-Covid’ policy, real estate deleveraging, tensions with Taiwan and ongoing fears about regulatory pressures have all weighed on sentiment.

The 20th Party Congress, which concluded on 22 October, further spooked markets. At the assembly, President Xi cemented his power at the top of the party by confirming a third term. He also announced a new leadership team composed mostly of loyalists. Investors are worried the appointees will focus on security and state control over business-friendly policies. They were also disappointed at the lack of a specific timeline for ending the country’s zero-Covid policy. The MSCI China Index fell 6% the following day.

Looking beyond the headline – key takeaways from the 20th Party Congress

The overall market reaction has been extremely negative. This is despite the fact that Xi’s third term was widely expected. There were also no new major policy announcements. And, while the long-term possibility of a policy misstep has increased, the new leadership structure potentially offers more clarity at the top. Xi also restated the government’s 2021 Common Prosperity Drive. The overall goal is create a more modern and socially equal society, with improved the living standards of all citizens. In the long term, this bodes well for ongoing growth in domestic consumption.

Meanwhile, to counter pressure from the West, China’s new economy and pro-innovation focus will also drive technology localisation efforts, enhancing self-sufficiency and the overall resilience of the economy. Xi seems serious in his ambition. At least six new Politburo members hold qualifications in science and technology fields, such as rocket science, nuclear power safety and public health. For investors, we believe this renewed focus will accelerate investments in areas such as renewable energy and domestic semiconductors.

The government also remains committed to increasing overall competitiveness. To achieve its aims – and in the face of increasing tensions with the US – China will need the backing of financial markets, foreign capital and overseas allies. It’s therefore logical to expect additional supportive policies for the domestic economy.

Given these restated economic aims, we think the regulatory reset that started in 2021 has entered a more stable stage. Xi also made several overtures to the private sector during his speech. The current balance between private firms and state-owned enterprises (SOEs) is therefore set to continue. The leadership team will also be acutely aware that they risk social instability should the current economic conditions fail to improve.

Zero-Covid policy remains – but is easing

While the zero-Covid policy remains in place, policymakers are gradually easing restrictions. On top of the real estate sector, China’s outlook for 2023 depends on whether the economy will open up, with the consequent boost to consumer spending and domestic demand. We expect an announcement on the strategy at the March 2023 National People’s Congress.

The Green agenda is still alive

President Xi reiterated the country’s commitment to Net Zero by 2060. China dominates global manufacturing capacity for renewable energy and storage, accounting for 90% of solar and 75% of battery capacity. Decarbonising economies require huge investment in renewable energy and storage, leaving China in line to benefit.

Other industries will also need to do their part to decarbonise. We therefore expect greater investment in upgrading machinery and increasing energy efficiency. We favour solar wafer producers, component makers, battery and related component makers, automation-related firms and companies focused on upgrading electricity grids for a renewable future.

Taiwan – what are the chances of conflict?

In a new development, the party amended its constitution to include a clause to ‘resolutely oppose and deter Taiwan independence.’ Despite this, we don’t believe there’s an imminent risk of invasion. For one thing, this would be highly counterproductive to Xi’s long-term objectives for China, which needs foreign capital, technology and support of the financial markets. The unified Western response to the invasion of Ukraine, including the utilisation of the dollar system against Russia, would also have given China pause for thought.

Where next for the economy?
Current economic conditions are challenging. While China’s third-quarter GDP of 3.9% year-on-year beat estimates, overall indicators point to the need for further fiscal and monetary easing measures. With zero-Covid only gradually easing, poor retail sales and high unemployment should continue to drag on the economy. Strong infrastructure investment could offset weakness in the property sector. Nonetheless, momentum in the latter is too anaemic for it to recover this year. Property sales have fallen sharply and will likely stay low amid impaired consumer confidence. That said, we think SOEs in the sector with continued access to funding are well placed to outperform.

Additionally, we see potential for stabilisation among large, well-established privately owned enterprise (POE) developers. Following consolidation of the party’s top echelons team – and importance of real estate for the economy – we would expect to see more coordinated support for the sector. This could see larger rescue packages rolled out if needed. However, there’s also a danger they sit on their hands for too long if a crisis emerges. Given these conflicting factors, default risk within the sector remains elevated.

Where next for equities?

Following recent market declines, equity valuations are attractive from a relative and historical perspective. MSCI China Index valuations are close to a 20-year low. It’s also worth noting that the weak macroeconomic environment doesn’t necessarily translate into weak fundamentals at the corporate level.

And then there’s the beleaguered digital-consumer companies (Alibaba, Tencent, etc.). They've been battered by zero-Covid, rising global interest rates and domestic regulation. However, the sector continues to generate high levels of cash. Valuations are therefore extremely attractive. Companies are now focusing more on profit and reducing investments. An uptick in sentiment and the continued generous dividend regime could therefore precipitate a sector recovery.

We maintain a preference for exposure to the more domestically focused China A share market, much of which remains under-owned and overlooked. Here, we continue to see a number of attractive stock-specific opportunities in long-term structural themes with policy tailwinds. These are:

Aspiration: rising affluence leading to fast growth in premium consumption

Digital: we see a bright future for cybersecurity, cloud, software-as-a-service and smart homes

Green: we’re positive on renewable energy, batteries, EVs and related infrastructure

Health: fast-growing disposable incomes are driving demand for healthcare products and services

Wealth: rising prosperity points to growth for consumer finance, investment services and insurance

Where next for fixed income?

Chinese SOEs have enjoyed healthy demand in recent months. We expect them to retain strong government support, although we remain cautious about valuations. We think onshore SOE spreads will remain tight in coming months, as onshore markets lack attractive assets to absorb the excess liquidity in the system.

We’ve trimmed core SOE positions due to rich valuations relative to Asian and global peers. For the same reason, we are underweight Chinese financials in the offshore market, especially big banks. We see supportive liquidity conditions for Local Government Financing Vehicles (LGFVs) in the near term, albeit amid growing concerns about the ability of local governments to provide support.

In the offshore China bond space, we favor:

  • domestic champions with limited geopolitical risk and continued ability to refinance
  • LGFVs with clear strategic roles within their province/region/city
  • real estate bonds with a low cash price in anticipation of restructuring or normalisation of the operating environment.

In the onshore China bond space:

  • we’re long duration versus the benchmark – we believe this serves as a good diversifier against other global assets
  • after trimming POE developers, we mostly favour stronger local SOE/LGFVs in onshore RMB credit
  • we’re neutral on RMB currency. Strong balance of payments should support RMB over the long term – although we think the direction of the US dollar will continue to dominate markets over the short term.

Final thoughts...

There’s much to consider as we head into 2023. The recent Party Congress unnerved markets. However, we believe the long-term China story remains in place. Moreover, companies that can adapt to emerging regulatory frameworks and align with policy objectives – such as digital innovation, green technology, access to affordable healthcare, financial services and improved livelihoods – should continue to prosper. As ever, in-depth research and first-hand local insights will be key to unlocking China’s vast potential. You can find out more about our China capabilities here. 


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