With concerns around global economic health resulting from rising inflation and interest rates, continuing economic disruption from COVID-19, and Russia’s military action against Ukraine, equity markets across the world are down.
China’s equity market CSI 300 is down 19.2% since the beginning of this year, compared to -15.1% for the S&P500 and -3.3% for the S&P/ASX2001
Russia and COVID-19 concerns – are they ‘overdone’?
For China, market concern is centred around two main aspects:
- Russia’s invasion of Ukraine and the spill over effect on China
- COVID-19 imposed lockdowns in major cities including Shanghai.
It may well be that these concerns have been ‘overdone’.
Spill over effect from Russia Ukraine conflict
Many have drawn parallels between Russia and China and the possible economic fallout should China suffer decoupling from global markets as Russia has.
China, accounting for 18% of global GDP versus Russia’s 3% and being the largest exporter in the world, makes cutting ties with China easier said than done2.
Although the rhetoric has ramped up as political tensions heightened, there has been no evident shift when it comes to actual trade.
On China’s COVID-19 situation, Shanghai has been under lockdown since late March 2022 . Being a metropolis generating over 3.5% of the country’s GDP3 the lockdown has unsurprisingly resulted in relatively weaker current economic data.
As of 17 May, Shanghai reached their internal target of three consecutive days of no new COVID-19 cases within the broader community, allowing the most stringent of restrictions to be loosened4. Already, Tesla’s Shanghai Giga factory is back online along with other manufacturing plants5.
Many believe the worst of the lockdowns may be over and the return to normality will only increase from here on, albeit with bumps along the way.
With the 20th National Party Congress to be held later this year, the government will do its utmost to ensure as much of the economy is back to normal and capital markets are functioning well if not riding on positive sentiment to ensure a smooth transfer for the next generation of China’s leadership.
Key aspects making the case for an investment in China
In addition to these factors, there are three broader aspects which may add to the case for an investment in Chinese equities:
- Policy divergence from the West
- Attractive valuations
- Chinese equities are substantially under-represented by the market and index providers.
China’s accommodative monetary stance
Contrary to the US’ monetary tightening stance, China is embarking on accommodative monetary policy settings6.
In addition to front-loading of fiscal expenditures, the State Council’s Financial Stability and Development Committee pledged to actively roll out accommodative policies in various industries that are conducive to the market. On 24 May, the State Council stepped up tax relief for Small to Medium Enterprises (SMEs) by 140 billion yuan7.
In addition, on 25 April the People’s Bank of China (PBoC) cut various borrowing rates including the required reserve ratio (RRR)8. These accommodative policies will be conducive “for the high-quality development and supply-side structural reform.”
It is expected that infrastructure, the digital economy, and green initiatives will receive further policy boosts in the future – areas where we see long term potential for China’s new economy.
We believe the market has priced in much of the downside risks.
The CSI 300 is now trading at 11.7x forward PE; one standard deviation below its three-year historical average.
The price corrections year to date has, in our view, made selected sectors and companies attractive for long term investors.
With the excessive selloff in the market partly driven by non-economic factors, our investment team is starting to deploy more capital into high quality companies in oversold sectors.
China is under-represented and under-allocated
Currently, China accounts for only 3.47% of the MSCI AC World Index10 (ACWI), with onshore listed A-shares comprising an even smaller allocation.
With China representing 18% of global GDP and having the second largest stock market in the world by market capitalisation, index providers simply must adjust China’s relative exposure to adopt a more true-to-form representation of the economy11.
With full inclusion, Chinese equities may comprise over 40% of the MSCI Emerging Markets Index and 6% of MSCI ACWI12.
This presents an attractive opportunity to allocate into China before both passive and institutional investors start adjusting their portfolios to reflect these benchmarks.
Beyond this, the diversification benefit and potential for alpha generation in a large inefficient market cannot be ignored by any truly diversified portfolio.