Lift off in China

Long suffering Chinese investors finally have something to cheer about – writes Andrew Courtney

 
The CSI 300, the broad-based index of China’s largest companies, is now up an astonishing 27% off its mid-September lows as the People’s Bank of China (PBoC) and politburo announced an array of measures and fiscal rhetoric to support equity markets and the broader economy.

Prior to the September fireworks, the benchmark Chinese index was on track for its fourth consecutive annual decline, down almost 50% from its February 2021 peak. The sell-off reflected challenges faced over the last few years, as the economy has struggled to emerge from the pandemic-driven lock downs which weighed heavily on its already overburdened property sector and domestic economy. These structural issues, and wider ideological challenges, meant the world’s second largest economy never experienced the post-pandemic rebound which drove many of its global peers to fresh all-time highs.

One of the root issues has been a distinct lack of fiscal measures which many major western economies relied on to underwrite consumer demand, thereby ensuring that even during the worst of the lockdowns, regular market activity never fully ground to a halt. This has long been a point of contention in China, even prior to the pandemic, as it has attempted to transition the economy away from its reliance on exports and infrastructure towards more domestic consumption. In order to achieve these goals, policy makers have leaned heavily on monetary easing to the point where there are now doubts about its efficacy, particularly now that house prices – which account for the majority of household wealth in China – have begun to fall.

This is a key reason why the recently announced measures have been so well received, especially those made by the politburo which signalled to ‘increase the intensity’ of fiscal support. As of yet, there are limited specifics around what this will actually mean in practice, however combined with the plethora of additional rate cuts and direct stock market support from the PBoC, it was enough to see mainland shares record their best weekly session since 2014 – noting that markets have been closed since 1 October for Golden Week.

While the market reaction has been dramatic, the consensus around the durability of these measures and whether they can have a real impact on the long-term economic trajectory – and the current threat of deflation – has so far been mixed. As Shehzad Qazi of China Beige Book notes:

“Beijing has no track record of effectively boosting consumer demand, nor did the Party lay out many concrete steps it plans to take here (disregarding “guidance” to localities). One can certainly hope for a wealth effect from stocks and property, but stocks will be temporary and the wealth decline from property is overwhelming compared to any relief.”

A more optimistic view is that the recent announcement from the Politburo could signal a change in sentiment towards the use of more aggressive fiscal policy and, as we have seen in recent weeks, if this does turn, this can happen quickly.

This appears to be the view from taken by Pacific Horizon Investment Trust (PHI) , which has a successful track record in the region, and has been steadily adding exposure in recent years – currently 22% of total assets are invested in China – as the managers look to capitalise on highly attractive multiples and growth trajectories provided by Chinese equities. While acknowledging that risks remain, the managers believe that the net potential is significant, particularly in higher growth sectors of the market such as technology and e-commerce. These areas have been identified as crucial to the domestic consumption transition and should benefit directly from any accelerated policy response.

PHI’s re-allocation towards China has bucked a global trend in recent years, with international exposure to Chinese equities at five-year lows. Notably, despite this relative bullishness, PHI’s portfolio remains underweight the MSCI AC Asia ex-Japan by almost 3 percentage points, highlighting the potential risks still associated with the region.

Another challenge is whether or not the good news – or the anticipation of good news – is already in the price. As Andrew McHattie noted on our weekly show today, the share prices of the three specialist China trusts (JPM China Income & Growth, Baillie Gifford China Growth Trust, and Fidelity China Special Situations) have all risen comfortably over 30% on average over the past month. McHattie notes that for those still looking to capitalise on these developments, a more sensible approach may be to look beyond these trusts to sectors standing to benefit from a Chinese recovery which have not yet seen the same level of investor euphoria, such as shipping (Tufton Oceanic Assets or Taylor Maritime Investments). Alternatively, a resurgent China will also likely benefit its Asian neighbours, providing possible value for trusts such as Pacific Horizon or abrdn’s Asia Dragon.

While there is a case to be made for front-running future fiscal stimulus, the reality is there remains a significant amount of uncertainty regarding both the policy outlook and the ability for any interventions to have a tangible impact on the real economy. Investors looking to capitalise should tread with caution.

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