Chinese equities are back under portfolio managers’ radar in the second half of 2022, as China starts to materialise its loose monetary policy and stimulus packages while coming out of Covid lockdowns and an emerging markets selloff.
According to data from EPFR, which tracks global fund flows and allocations, overseas China funds recorded a net inflow of $8.5 billion in the five weeks preceding July 7, with $4.1 billion and $4.4 billion into active and passive China funds, respectively — a clear contrast from a net outflow of $700 million during March and April.
In the second quarter, the Shanghai Composite Index rose 4.5%, while the Shenzhen Composite Index rallied 6.4%, making them almost the only benchmark indices of a major economy to record gains during the period.
But as the slowdown of the world’s second largest economy continues to loom amid the persistence of China’s Covid Zero policy, investors remain cautious. Still, the rebound story and the relatively loose monetary environment have put Chinese equity higher on their shopping list, as the rest of Asia, and even the world, experiences a different economic cycle and faces the pressures of inflation and rate hikes.
THE NEW GROWTH STORY
“For quite some time from a lot of our regional portfolios, we had seen better opportunities outside of China,” said Marco Giubin, senior portfolio manager for equities at Manulife Investment Management.
“However, there are areas in the Chinese market that are still going to be competitive and are going to be very attractive,” he said.
Across Asia, Giubin sees strong structural demand and growth opportunities in many industrial sectors related to electric vehicles supply chain, renewable equipment suppliers, industrial automation, and power grid equipment and infrastructure.
“A lot of these [new technologies] are in the China [A share market],” he noted. “I think the growth sectors are relatively new compared to what we've generally perceived to be the growth sectors in China. I think those are the areas we're going to be mostly focused on.”
On the contrary, China’s “old” growth sector consisting of big tech names is not favoured despite eased regulatory restrictions and their cheap valuations after rounds of selloffs.
“To me, I don't worry about regulatory crackdown so much anymore with these companies. I'm more worried about just whether in some of these areas we've actually hit a maturity level in terms of penetration, be it on e-commerce or online gaming.”
Though the market narrative and sentiment that “the worst is over” when Shanghai’s months-long lockdown was lifted and China’s State Council released a set of 33 measures to stimulate the economy, Giubin thinks there are still headwinds to the recovery as long as Covid Zero is still in place.
“The consumption environment is very difficult to gauge given what we're seeing with Covid policies and all the rest of it,” he said. “Domestic consumption, or Covid recovery, is certainly not something that we feel particularly comfortable exploiting at this point. And this is some sort of a policy shift.”
“We're not going to try to make any assumptions as to what stimulus they're going to come through with, I think it's a dangerous strategy,” Giubin summarised his views in Chinese equity selection, stressing that he will not make judgment and speculation on policy direction. Instead, he will wait and see what the policies are, and then call stocks based on fundamentals.
“From a policy support perspective, we've been very disappointed with the lack of meaningful policy support. It's been insufficient and not proportionate to the size of the economic challenges facing China,” said Sue Trinh, head of macro strategy, Asia at Manulife Investment Management.
Nonetheless, emerging market funds are becoming more optimistic about China relative to other emerging markets. Although on average, active emerging market equity funds still underweight China compared to the MSCI EM Index, the extent of underweighting has been narrowing since the third quarter of 2020, according to analysis of China Asset Management (ChinaAMC)’s global capital team.
Schroder’s outlook for the second half echoed the trend, as the firm maintains underweight on equities amid rate hike concerns and recessionary risks. But within the equity portfolio, it moved to overweight Chinese equities against developed equities, as China is in a different cycle to try to stimulate and be accommodated while the rest of the world is tightening up.
“It offers us something very different. Therefore, we are turning more positive on Chinese equities within the global market,” said Keiko Kondo, head of multi-asset Investments, Asia at Schroders.
She also noted that after international investors’ selloff, Chinese equities are “very” under-owned. “From the valuation viewpoint, Chinese equities on the offshore market, depending on the index — there were a couple times that it was approaching a price-earnings ratio (P/E) of 10, which is very, very low.”
Although the overall equity portfolio is tilting toward value stocks, Kondo said China will be the one market that they don’t mind owning a bit more in the growth sectors offshore, as the stocks’ ability to bounce back after global selloffs is strong, and they also have much more upside than equities in other markets.
Kondo said she’s not so worried about US sanctions against Chinese companies, including the delisting risks of China American depositary receipts (ADRs). She thinks such risks have been priced in, and the US has other priorities given a tough economic environment domestically.
In onshore China, Kondo favours the cyclical sectors more than the growth sector, as the market is dominated by local investors. The local focus in the second half will be more on the government’s economic stimulus, she noted.
For local investors, the outlook for A shares is also much more optimistic in the second half. “China’s GDP growth and corporate earnings are picking up on a stronger footing since June,” noted ChinaAMC’s global capital team.
They are more positive about growth sectors with high earnings visibility and value companies with sustainable growth. Their top picks are renewable energy and the consumer sector.
The renewable energy sector benefits from continued policy support, and market demand remains robust both domestically and overseas, given elevated energy prices, they said.
In the consumer sector, they expect a rebound of goods and service consumption as Covid restrictions are gradually relaxed. “Electric vehicles, consumer discretionary, service consumption companies are in the focus list,” they said.