Investors can now assess China’s markets according to the directions given at the end of the 20th National Congress of the Chinese Communist Party.
As an initial reaction, shares in Chinese companies saw a drop on Monday, October 24, when Hong Kong’s Hang Seng Index closed the day at 6.4% down, seeing its worst one-day rout since 2008. The Hang Seng China Enterprises Index, a benchmark of Chinese stocks listed in Hong Kong, went down 7.3%, in its worst showing after any Communist Party congress since the inception of the index in 1994.
Furthermore, tech giants Alibaba Group Holding, Tencent Holdings. and Meituan all tumbled more than 11% in price.
Foreign investors fled the mainland markets, selling a record amount of equities via trading links in Hong Kong and fuelling a nearly 3% loss in the CSI 300 Index. The onshore yuan fell as much as 0.6%, to its weakest since January 2008.
Against this initial backdrop, AsianInvestor asked asset managers how investors with allocation plans to Chinese assets should assess the coming five-year term, and what new investment opportunities and trends could emerge during this half-decade.
The following contributions have been edited for clarity and brevity.
Victoria Mio, head of equity research in Asia Pacific
While international investors may have been looking for more specific and explicit economic announcements, the outcomes of the party congress meeting should have been expected. We now have numerous hints as to where policy direction will go in the future and an expectation for further encouraging elements still to come. A healthy economy remains vitally important to achieving policy goals.
With the congress concludes, we expect to see a number of key developments that could positively impact the economy, including the meeting of Presidents Xi and Biden on the margins of the G20 Summit in Bali, where we could see a stabilisation of the relationship, the economic meetings in China in Q4 and Q1, and an emerging path out of zero-Covid which has been acting as a cap on broader economic activity.
We believe that China’s long-term growth model is moving away from heavily focusing on investment and property construction, to a more consumption-driven, high-end manufacturing and innovation-driven economy - manufacturing, renewable energy and EV supply chain sectors are likely to benefit. In the shorter term, we remain defensive on Chinese equities, favouring consumer staples, healthcare and utilities.
Takahiro Tazaki, global head of product specialists
Nikko Asset Management
Japanese investors like other investors are waiting for the Central Economic Work Conference in December by the new leaders to see if there is any pivot of the economic policy, including the growth and Covid strategy. We think investors will take a conservative attitude until they get a clearer picture.
The initial reaction of the conclusion of the Party Congress was bearish, as shown in equity and RMB markets, and Japanese investors are carefully watching how long the fund outflows from overseas investors continue.
Under these circumstances, we still think China government bonds as defensive assets are relatively attractive, given the contained inflation and the easing policy, which is opposite of the policies in most developed markets. As the uncertainty of the global growth outlook increases, the demand for China bonds would increase.
Lorraine Tan, director of equity research in Asia
The new seven-man CCP Standing Committee implies a more hard-lined approach to covid policy and security at the potential expense of economic growth. This means that GDP growth is likely to notched lower for 2023. As such, there should deeper earnings estimates downgrades for China companies. The rise in risk is also because government policy is expected to be more opaque going forward. This implies greater uncertainty and risk. We continue to expect markets to remain volatile until there is see clear details on policies to address the real estate decline.
For investors with a three-year horizon, there are high-quality names at attractive prices presently and we advocate being selective with a preference for deeply discounted moaty names. For example, we see opportunities in Chinese e-commerce and interactive media companies, where regulatory risks have eased. We continue to expect interest rate hiking worries to reduce by the end of first-quarter 2023, and this should allow appetite for equities to return.
Ken Shih, head of wealth management Greater China
From an allocation perspective, Saxo is underweight China as a precaution. We see risk premiums for all Chinese assets (equities, fixed income, and the yuan) have risen across the board. But Chinese stocks are looking for a bottom, and investor interest can return to Chinese equities very quickly once we see more indication how capable the new leadership team is in returning China back to a path of growth. Even though the sentiment is poor right now I don’t believe investors should sleep on China.
Saxo is positive about the prospect of an economic recovery in China in 1H 2023, when the credit situation has bottomed out. We prefer Chinese stocks with policy driven benefits related to the real economy, such as mining, energy, infrastructure, manufacturing, and rural area development. Chinese tech sector-wise, we are medium- to long-term bearish on mega-cap China internet companies and in favor of smaller and emerging technology companies.
Alec Jin, investment director for Asian equities
Several overtures to the private sector were made during President Xi’s speech; the status quo in the economy, of balance between SOEs and private enterprises, is set to continue, alongside the roll of markets, which were acknowledged as playing a determining role in resource allocation. Overall, the messages were supportive of a general reduction of immediate near term regulatory pressure.
We believe there will be more support in terms of industrial policy. Xi also called for “greater self-reliance and strength in science and technology” in his speech, highlighting an economic policy mix where economics and growth still come first but where security, equality, and self-sufficiency have been elevated. In this context, we see the drive towards self-sufficiency and localisation as gaining in importance, and this is likely to accelerate investments in areas such as renewable energy and domestic semiconductors.
Besides, the theme of green energy aligns with government policy on decarbonisation and net-zero emissions by 2060. China dominates global manufacturing capacity for renewable energy and storage, accounting for 90% of solar and 75% of battery capacity. Decarbonising economies require huge investments in renewable energy and storage, leaving China in line to benefit. Other industries will also need to do their part to decarbonise, so we expect greater investment in upgrading machinery and increasing energy efficiency. We favour solar wafer producers, component makers, battery, and related component makers, automation-related firms and companies focused on upgrading electricity grids for a renewable future.
Alexander Treves, head of emerging markets and Asia Pacific equities investment specialist
J.P. Morgan Asset Management
The upcoming Central Economic Work Conference and National Financial Work Conference are expected to announce key economic policy directions, but we don’t think there will be a major shift. Goals such as sustainable growth, common prosperity, and social stability are likely to persist. While we believe the Chinese government will continue with the dynamic Covid-zero policy in the near term, we do expect some fine-tuning, which could help support consumption in the longer term.
In terms of sectors, we remain constructive on carbon transition-related companies such as the solar and electric vehicle supply chain, as China is committed to ensuring energy security and a more environmentally friendly economic growth model. We also favor domestic technology companies amid the push for self-sufficiency, especially in industrial automation and technology innovation (both hardware and software). However, differentiation between company-specific opportunities remains critical, as the implications of more of a focus on quality and sustainable growth could vary by sub-sector. Those companies with a better ESG focus and strong execution capability should be winners over time.
Ben Luk, senior multi asset strategist
State Street Global Markets
While the 20th Party Congress shapes the direction of what to expect in the coming years, we are still at an early stage of any major macro implications to the economy. The upcoming quarterly Politburo meeting alongside the Central Economic Work Conference would be just as meaningful in providing investors greater clarity on the economic side for the years ahead.
We retained our underweight conviction towards Chinese assets for much of 2022, as we see ongoing challenges on the macro front that have led to deteriorating earnings fundamentals. As long as we don’t see a meaningful rebound in the real economy, it is unlikely for us to increase our allocation towards China, especially with institutional investors still extending their underweight position across Chinese equities.
While valuation is looking increasingly attractive, valuation itself is not a catalyst to move markets higher. We cannot rule out certain sectors that could benefit initially, such as defense, healthcare, or energy transition, but we caution this optimism is based purely on policy signals, as these corporates can once again be downgraded if future earnings growth does not live up to markets’ expectations.
Jonathan Pines, head of Asia ex Japan
Federated Hermes Limited
Investors in China have had a lot of reasons to be bearish: zero covid, common prosperity policies, property market concerns, the potential delisting of US-listed ADRs, and tensions with the US. To all of that has now been added a tighter grip by President Xi on how the country is to be run following his appointment of close allies to key positions. While not universally unexpected, this last move has caused some investors to finally throw in the towel, with the most dramatic impact on technology stocks.
The key risk we are concerned with remains geopolitical, in terms of China’s relationship with the US, rather than domestic policy-driven concerns. We believe that China does have some mechanisms that will exert some pressure on the authorities to act if growth continues to be threatened to the extent it affects the economic wellbeing of its citizens. Indeed, we believe that we are at that point now where we expect the will or practical ability of the President to adopt anti-growth or anti-business policies [to be limited].
Chinese stock valuations are now probably at a record low relative to the rest of the world. Very substantial risk has been priced in, as investors focus on what could go wrong in China. However, things could also “go right”. Zero covid policies could be reduced, a purported meeting between President Biden and President Xi could result in a lessening of tensions, China could unexpectedly adopt pro-business policies, the government could act more decisively to help the property sector, or adopt a massive fiscal or monetary stimulus.
We consider Chinese technology stocks (like many non-tech Chinese stocks) to be too cheap relative to fundamentals. There are admittedly potentially geopolitical near-binary risks that might hurt investors investing now, despite current cheap valuations; however, on a probability adjusted basis, we consider it a risk to be worth taking.
Wing Chan, head of manager research in Europe and Asia Pacific
From a portfolio standpoint, we try not to react to political events but instead, place a greater focus on long-term fundamentals and valuations. If investors have already made plans to invest in China's growing financial markets, the recent volatility may provide a comparatively more appealing entry point for long-term investors.
The caveat of course, is that investors may wish to consider "right-sizing" their allocations based on their own risk tolerance, since China remains a single country market and it often pays to maintain a well-diversified portfolio across geographies, asset classes, along with industries and sectors.
Tan Yong Hong, head of credit research for Asia fixed income
One of the key takeaways from the 20th CPC Congress meeting was the focus on building up the resilience of China’s domestic economy in core areas, such as technology innovation and green development. This emphasis could result in policy support shifting towards companies involved in the development of technological capabilities, such as those in the semiconductor and defense sectors. We may also see less unsettling regulatory actions that have weighed on technology giants in recent years.
On the green front, investments in green infrastructure and low-carbon sectors are likely to grow in tandem with the government’s green ambition. Bond issuers who can be potential beneficiaries of this development include non-coal power producers, as well as natural gas distributors.
We also expect domestic consumption to play a bigger role in driving growth, as opposed to investments. This could benefit companies that capitalise on consumer spending, even as earnings are dampened by the Dynamic Zero Covid policy in the near term.
However, we are cautious on companies that are more likely to be caught in the crosshairs of the increasing geopolitical tensions with the West, while leaning towards SOEs that have a more domestic focus and are thus less vulnerable to geopolitical risks.