China jumps in the Year of the Rabbit

This Sunday marks the start of the Year of the Rabbit in China, which symbolizes prosperity and longevity. Wenli Zheng, portfolio manager of T. Rowe Price’s China Evolution Equity Strategy, expects the Year of the Rabbit to flourish for Chinese stocks as well.

“Since the party congress in October, Chinese politicians have been working hard to solve the two biggest problems that have dragged down the Chinese economy and stock market sharply over the past 18 months: Covid and the crisis in the real estate sector.

The Covid policy has clearly been adjusted with the reopening. In addition, the 16 measures to support the real estate sector are expected to stimulate the recovery of this industry.

Wenli Zheng

Significant growth in corporate profits

For investors looking for where to invest their capital, China stands out, not least because inflation is low, in stark contrast to all the other major economies. While the Western world grapples with rising interest rates and quantitative easing, China is following a different course by pursuing an accommodative monetary and fiscal policy to support economic growth.

China’s current economic challenges are not the result of rampant inflation, but of the country’s zero covid policy combined with a self-inflicted real estate slowdown. Zheng sees an improvement in both areas. The rise in infections from China’s reopening will hurt the economy in the short term, as evidenced by the weak PMI in December. However, Zheng believes that the pace of the recovery may also be faster than the market expects. The reopening is likely to give a significant boost to domestic consumption and private investment.

“The pace of the recovery may also be faster than the market expects”

With institutional investment in Chinese stocks at five-year lows and cyclically adjusted valuations well below average, the risk/reward ratio is now favorable. Chinese corporate earnings were squeezed in 2022 by Covid and the real estate slump. However, the consensus expects that China’s growth in earnings per share will accelerate in 2023 from 2% in 2022 to 10% this year. China is in a unique economic cycle and I expect corporate earnings to accelerate significantly in 2023.

“China is in a unique economic cycle”

China remains crucial in the global supply chain

China’s supply chain strength is robust despite concerns about possible disruption. Foreign direct investment in China will increase by about 20% in 2022. China’s industrial investment accounted for more than 60% of the global total in 2021, and industrial output accounted for 30% of the global total.

China has lost share in labour-intensive sectors such as clothing, furniture and electronics assembly. On the other hand, the country has rapidly gained share in technology-heavy sectors, such as auto parts, electronic components and other equipment (such as related to EV batteries, smart grids and fracking). China’s demographics have moved from headwind to headwind, but the education and technology dividends are only just beginning to pay off. More new technicians are trained in China each year than in all OECD countries combined.

“In China, more new technicians graduate each year than in all OECD countries combined”

Selective decoupling is taking place in strategic high-tech sectors such as advanced semiconductors, biotechnology and possibly electric vehicles. This could slow down China’s development in certain fields, such as high-performance computing and artificial intelligence. On the other hand, concerns about supply chain security have contributed to faster local substitution in energy, semiconductors, analog technology and medical devices.

Investment opportunities

China remains an attractive country for investors, but like the rabbit, it is important that they remain agile and move quickly. I expect China’s market leadership to expand and investors will need to look beyond the familiar mega-caps to identify future winners.

Themes that T. Rowe Price is following closely include the search for the best growth opportunities in China, which will emerge stronger from the economic slowdown. Examples are online recruitment, operators of shopping centers and hotel chains. In addition, we also see plenty of opportunity in companies that are doing well despite the weak macro climate, such as auto parts and industrial companies involved in energy transition, shipbuilding and oilfield services.

With more visibility on Covid policies and the real estate market in 2023, I expect several domestic sectors including non-essential, business services and advertising to accelerate towards the second half of the year. These are sectors where companies with very strong business models are usually active. More attractive opportunities will be found in these sectors as the economy improves.”

Four Chinese stock picks from Morningstar

Leave a Comment