China’s already slowing economy has been further dragged down by nationwide power shortages across factories and households, leading investors to take a more cautious approach to their China exposures.
Surging coal prices and China’s carbon neutrality push limited factory access to power earlier in the summer, forcing them to halt production. But news about the power crisis only reached mainstream media when the shortage extended to ordinary households in late September as homes in northern China were hit by sudden blackouts.
The power shortage coincides with a global energy crisis spreading from Europe amid efforts to cut the use of fossil fuels. The price of natural gas and coal, for example, has surged to record highs as the post-pandemic recovery collided with supply cuts to meet countries’ net-zero targets.
The power crunch will likely slow China’s economic growth, which has already dropped from 18.3% in Q1 to 7.9% in Q2 this year. In a worst-case scenario, BNP Paribas estimates that a further two percentage points will be knocked off in Q4 on an annualised basis, corresponding to a 0.76pp loss in full-year GDP growth.
Under such a context, some investors believe that the power crunch reaffirms an opportunity for investors to start raising China exposure and invest in the green industry, while others see it as a reason for global investors who are underweight on China to walk further away.
AsianInvestor asked Asia investment strategists and fund managers how the power shortage in China will affect their approach to the market, and the major risks and opportunities to watch for.
The following contributions have been edited for clarity and brevity.
Andrew Zurawski, associate director, investments Asia
Willis Towers Watson
It is difficult to estimate the impact of power shortages on China’s economic growth given the uncertainty over how prolonged this episode will be. We foresee this impact to be small and we are still projecting strong growth in China over the next few years, albeit a little weaker than what we expected earlier this year.
Adding to the ongoing supply chain blockages, the main short-term risk we see from China’s energy shortages is the increase in Chinese and global inflation for a more prolonged period. Longer-term, the shift in China’s climate policy could also impact the volatility of commodity prices. Under this higher and more volatile inflationary scenario, we see global assets such as real estate, infrastructure and commodities as outperforming. These assets tend to have natural hedges against inflation while more traditional assets such as bonds and equities tend to underperform.
Overall, our assessment is that Chinese assets remain attractive over the medium to long term given our expectations on its strong economic growth, relatively high bond yields compared to developed markets and diversification benefits. Global asset owners generally remain under-exposed to China and we continue to recommend lifting this exposure. From an implementation perspective, we firmly recommend an active approach to take advantage of market opportunities and help the asset owner better manage risk.
Yichan Shu, senior investment strategist, Asia Pacific
State Street Global Advisors
From a multi-asset investment perspective, we are more cautious on China equities compared to US or European equities for the short-term. China’s power outages, along with rising material costs and supply-chain bottlenecks are likely to remain a drag on the economy. The potential for further Covid-19 outbreak and broadening regulatory crackdown would represent additional headwinds to corporate earnings growth in the second half of the year.
From a macro standpoint, lower growth should lead to bias for easier liquidity in China but complicated by potential short-term Producer Price Index (PPI) inflation uptick. Chinese bonds should be supported but credit may remain pressured. This will further support our call for accessing China bonds via high-quality government and quasi-government bonds instead of credit even though spreads are very attractive.
With regards to sectors, we take a long-term fundamental view in forming our sector positions. We are currently overweight consumer discretionary, consumer staples, healthcare and communication services in Chinese equities. We do not see the recent China power outages as a long-term disruption to our sector positions.
Chaoping Zhu, global market strategist
JP Morgan Asset Management
The power cuts directly affect output and revenue of manufacturers, and indirectly increase costs for the consumption and services sectors. Under such circumstances, investors might remain cautious about China’s corporate earnings for the fourth quarter. Meanwhile, the volatile global market is expected to further weigh on investor sentiment in the near term.
Over a longer time horizon, the impact of power shortage might fade in the first half of 2022, when the new annual emission target is in place, and the authority might roll back some of the extreme local power cuts.
After this year’s intensive policy implementations, we expect the policy environment to stabilize in 2022, and the monetary policy to become more accommodative to support domestic demand. As a result, market sentiment might rebound in 1H22, and risk assets may outperform.
In terms of asset allocation, it remains important to take a diversified approach to manage market volatility. Income stocks and high-grade local government financing vehicle (LGFV) bonds could provide downside protection to investors in the near term. Active management remains crucial when investing in Chinese assets, we remain constructive on the prospect of the Chinese technology sector, and we view the potential short-term market correction as an entry point for long-term investors.
Although the power crunch could remain as a downside risk for overall GDP growth and PPI inflation, in the mid to long term this should be positive for the renewable industry as local governments will place a higher priority on the use of renewable power. Stocks that are better positioned on the ESG front are expected to weather the challenges better.
Simon Weston, head of Framlington Asia
AXA Investment Managers
China’s growth rate was already slowing ahead of the recent news flow about power shortages, and although the latter will likely increase the rate of slowdown, it will not change this growth trajectory. Investors have been faced with this slower growth environment for some time, so this news is unlikely to significantly change their asset allocation approach to investing in China. Recent surveys have indicated that global asset allocators are typically underweight China, and this stance will likely not reverse if estimates are cut further.
More critical will be how the authorities respond to the recent slowdown and what measures they may take to support growth, especially given that some of this weakness has been policy-induced, especially with respect to the real estate sector.
Meanwhile, major policy initiatives in such areas as renewable energy and clean technology provide potentially attractive investment opportunities given their strong structural growth drivers in combination with the tailwinds provided by this policy support. Thus, investors who remain committed to the China markets will need to continue to have a thematic and bottom-up approach when looking for attractive investment opportunities.
Chris Liu, senior portfolio manager, China A-share investments
In the short term, the power cuts cause supply disruptions in energy-intensive sectors such as steel, aluminum and cement, paper and glass, etc, but the impacts might not be all negative as the declining sales volumes might be offset by rising product prices.
We see opportunities in sectors such as electric vehicles (EV), alternative energy, and healthcare. EV is part of the green industry and there is no power rationing for battery makers. For alternative energy such as solar and wind power supply chains, local governments are encouraged to promote and consume that to meet their carbon annual targets. In terms of healthcare, energy intensity is very low and the valuations have come down with long-term growth drivers intact.
Jie Lu, head of investments China
Although we think China will relax certain restrictive measures and loosen the macro policy to support growth, the disruption from power outages could continue into the fourth quarter, which will put pressure on the earnings revision outlook.
Together with the potential property sector risks, we are cautious on Chinese equities in the near term and recommend selective names in upstream and utilities sectors and cautious about the downstream sectors with the difficulty for price pass-through, as PPI-CPI gap could sustain. Quality companies with scale and higher efficiency may benefit in the long run.
China’s policy priority is shifting from speed of growth to quality and sustainability of growth, and from efficiency to equality. The Chinese market still offers attractive investment opportunities in the long run.
Themes and sectors that are likely to benefit from China’s policies include: Carbon neutrality: EV and EV battery, new energy, new materials, and environmental protection sectors; self-sufficiency: tech hardware, semiconductors, agriculture-related sectors important for China’s food security; industrial upgrade: advanced manufacturing, industrial machinery and equipment sectors, and software and AI-related sectors; capital markets and asset management development.
China also needs to rely on capital markets to support innovation and small and medium enterprises (SMEs), as demonstrated in setting up the Beijing Stock Exchange recently.
Pruksa Iamthongthong, senior investment director, Asian equities
The power cuts reaffirm long-term structural demand for green energy in China and underline the investability of its broader energy transition, not just for the next 12 months but for decades. This will present opportunities to invest in companies positioned to enable China’s energy transition technologically.
It should also benefit those at the forefront of efforts to switch to cleaner energy. Firms that diversify their energy sources will not only improve their carbon footprint, they will also be more resilient to power cuts in the future.
On the flipside, disruption to supply from a reduction in production will weigh on sectors where component shortages are already causing bottlenecks, such as technology. The longer this shortage in power supply persists, the greater the likelihood we will start to see component costs increase.