Investors are revisiting Chinese equities going into 2023 as the country gradually reopens and economic activities normalise. But a bottom-up approach is necessary along the road of China’s bumpy recovery, fund managers say.
In a major policy shift, China dropped its zero-Covid approach in early December, ending the country’s year-long massive lockdown and testing mechanism in favour of self-testing and home quarantines for asymptomatic and mild cases. As infections surged in the cold-weather central and the northern areas, including Beijing, however, economic activity has also seen some disruption.
Paul Kalogirou, head of client portfolio management for Asia at Manulife Investment Management, noted that global investors’ allocation to Chinese equities is dependent on the level of domestic mobility and consumption as the economy recovers.
“The first one to three months going in winter is going to be pretty disruptive towards the economy as China reopens. So, we're not going to see until second quarter next year in terms of transparency around those mobility and consumption levels, but obviously markets could react before that if [macro] data starts to get better,” said Kalogirou.
Overall, the market expects China's reopening to gain meaningful momentum after March 2023, as the weather warms and more policy direction is given during the national legislative meeting, or Two Sessions, that month.
“It's a case of being very cautious in our allocations within Chinese equities and debt currently,” he stressed.
Manulife IM holds a neutral position on Chinese equities in 2023 in order to retain exposure to the country’s long-term growth prospects. These include the reopening theme and domestic semiconductor-related technology companies. Over the longer term, the firm also likes renewable and green technology themes, Kalogirou said.
Overall, the firm is selective around sectors related to policy, innovation, and infrastructure.
Although onshore and offshore Chinese equities were among the worst performers globally in 2022, they staged a rally in November as China started to relax domestic Covid restrictions. The Hang Seng Index (HSI) and Hang Seng Tech Index surged 26.6% and 33.2% in November, while the Shanghai Composite Index rose 8.9%.
On December 19, the Securities and Futures Commission (SFC) and the China Securities Regulatory Commission (CSRC) jointly announced the expansion of stocks eligible for trading under the Mainland-Hong Kong Stock Connect.
The expansion will give international investors more choices in A shares in northbound trading, which will now include stocks that have a market capitalisation of Rmb5 billion ($715 million) or above and meet certain liquidity criteria.
The scheme will also expand southbound trading to allow mainland investors to invest in foreign companies with primary listings in Hong Kong that are constituents of Hang Seng Composite Indices.
Preparations for the adjustments will take about three months, the regulators said.
Furthermore, on December 16, the US audit watchdog Public Company Accounting Oversight Board (PCAOB) announced that it gained full access to US-listed Chinese companies’ audit records, removing a cloud of delisting worry around 200 Chinese firms listed on the US stock exchanges.
Sue Trinh, co-head of global macro strategy also at Manulife Investment Management, noted that the competition and confrontation between the US and China exists across multiple domains, and any geopolitical risk premium taken out of the market might be a little “premature” given intense scrutiny is likely to persist across global supply chains.
Trinh cited trade, technology, military, climate, capital markets, as well as cross-border data protection, as potential continuing areas of friction. She suggests careful bottom-up due diligence given the heterogeneous nature of the Chinese equity market.
Meanwhile, taking note from the recoveries of other economies earlier this year, Trinh said pent-up demand could fuel inflation both in China and in other parts of the globe.
Geopolitics aside, Keiko Kondo, Schroders' head of multi-asset investments for Asia, is taking a more cyclical approach towards Chinese equities.
“Now that we are beginning to see a gradual reopening, we believe that it is likely to translate more to growth and activities that need to recover,” said Kondo.
“It's not about the political risk or anything but simply the cyclical nature of the market when we think about the economic activities resuming with the reopening,” she said. “Obviously, this market, you have to be careful with the volatility. But generally speaking, there is still more upside because they have been underperforming so much.”
Noting that the onshore Chinese equity market is more driven by the domestic economic cycle and that offshore equities are more reflective of international investor sentiment, Kondo said the larger upside of Chinese equities in 2023 will be seen in the offshore market, along with higher volatility.
Investor sentiment will swing along with China's recovery path, which is “not going to be a one-way smooth ride”, she said. Hence, the firm hasn’t shifted from underweighting emerging market equities, including China, to an overweight position.
“We believe that investor sentiment is still quite fragile. And when we talk to our clients, one thing people don't want to have is too much volatility given how difficult the environment has been," Kondo said.
Going into 2023, Schroders holds a neutral position on Chinese stocks but is more bullish on the markets versus other emerging market equities. Many emerging markets are export-oriented economies that are closely linked to the global economy, which faces a potential recession and weak demand in 2023, according to Kondo.
The firm will look at value stocks that will benefit from the broad economic recovery in the onshore market. Offshore in Hong Kong, the big liquid names that usually do well when investor sentiment rebounds, including tech stocks, will be on their radar.
Hyomi Jie, equities portfolio manager at Fidelity International, favours China’s consumer sectors, noting that earnings expectations had bottomed out based on monthly data the firm collects. Jie’s sector picks include leisure, travel, and dining-related companies, as well as nightlife and outdoors-related companies.
As the broader reopening theme is now priced in, Jie said her team is taking a bottom-up approach, focusing on stocks whose share prices haven’t fully reflected the growth and earnings normalisation.
Editor's note: This story has been updated with new information related to the Mainland-Hong Kong Stock Connect scheme in paragraph 10.