China - Turning a Corner?

Chinese equities were resilient in 2020 as the country (ironically) avoided the COVID-19 recessions that afflicted most other economies. China then heavily underperformed after implementing strict zero-COVID policies and scoring a slew of policy own goals. Foord Singapore portfolio manager JC XUE looks at whether China has now turned a corner.

Chinese equity markets lagged global bourses in 2021 and 2022 on persistent lockdowns, deteriorating economic prospects, US tech export restrictions, military posturing and swingeing regulatory interventions. The market all but capitulated in early October, after President Xi consolidated his power base at the 20th National Congress of the Chinese Communist Party.

Chinese company valuations were already cheap heading into the party congress. But share prices fell sharply on fears that the new politburo would exacerbate suboptimal policymaking. Lack of meaningful changes to China’s zero-COVID policy compounded the disappointment. At its October 2022 trough, the Hang Seng Index traded at a record-low PE multiple (which measures the valuation of a stock market or share).

Today, China is rapidly dismantling its zero-COVID policies, despite rising COVID-19 caseloads. The government is also reviewing its policies for the technology and education sectors, supporting its real estate sector and seeking to boost private-sector confidence. By year-end, the Hang Seng Index had rebounded ~35% from the trough. This is evident in the excellent fourth-quarter returns of the Foord global funds, with the Foord Global Equity Fund having about 25% of its investments in the region and the Foord International Fund about 10%.

The managers largely maintained the funds’ Chinese investments through the market turmoil, given the exceptionally low valuations and our estimation for normalising economic growth as pandemic constraints eventually eased. Add to that prospects for attractive earnings growth from an economic upcycle and the upside potential was very attractive.

Looking ahead, we note positive signs despite the elevated political risks. While the politburo is now staffed with more of Xi’s men, they are not without credentials. President Xi has himself reiterated that economic reform would continue, and the opening will ‘only be wider’. Despite negative media portrayal, next premier Li Qiang is known to be business friendly, having sponsored the STAR market (science-and-tech-focused stock exchange) and brought the likes of Tesla to Shanghai. He Li Feng, who should succeed Liu He as the economic czar, is an experienced pro-growth candidate.

All signs suggest that the Chinese market cycle has started to turn. Prospects are positive heading into 2023, especially compared to rest of the world. However, we do not invest in a China index, we invest in quality Chinese companies largely calibrated to the inevitable growth of the Chinese middle class. In our view, these carry less investment risk, but will appreciate with the prospects of the whole economy. The position size of Chinese stocks will continue be judged relative to the respective risk mandates of the portfolios we manage for investors.