It’s been a challenging few years for the China equity market, and Beijing’s recent abandonment of Covid-Zero has put the country back in the headlines again. With 2023 set to be a turning point, we asked Portfolio Manager Siguo Chen, to give her views on what to expect from China this year.
As an on-the-ground investor in the region, what’s your perspective on China’s recent exit from Covid-Zero?
China currently finds itself in an awkward situation with regards to the U-turn of its Covid-Zero strategy. The reopening has been welcomed by the general public but we need more clarity on certain aspects.
Following the original Covid outbreak in 2020, China’s draconian rules and the effective execution of these rules enabled it to remain relatively insulated from Covid. However, the success of these rules emboldened the government to continue with its policy well beyond the ‘sell-by date’.
This is partly because the government tied its reputation to the success of its Covid policy and found it very difficult to extricate itself, and also because much of China’s huge population had no exposure to Covid and therefore lacked immunity. The government knew that any reopening would be painful.
How has this impacted the economy and society?
As time goes on, the pressure on the economy – and on morale – has become more pronounced. From our team’s analysis, we see that the three key pillars of China economy’s – consumption, property and exports – are all under huge pressure. Social stability has also become an issue and this is something that concerns the government greatly.
In October, we formed the view that China needed to change its Covid-Zero policy sooner than it wanted to, i.e. in March 2023, rather than the end of the year. However, when the reopening happened, it was sooner than we – and many others – had expected.
Although the intention to fully reopen is clear, the pace is contingent on healthcare not becoming overwhelmed. It is too early to tell whether the healthcare system will be able to cope with infections, given the sub-optimal capacity, and the disparities in healthcare between regions.
What does this mean for your positioning?
We are well positioned towards a full reopening, with our highest conviction ideas in healthcare, travel and consumption. However, we know the importance of having a balanced portfolio and we are also positioned beyond the reopening, for example, towards the technology sector.
Moving on to geopolitics, what’s your view on the China – Taiwan situation?
We believe that a war between China and Taiwan is highly unlikely. China and Russia are often spoken about interchangeably in this regard, however the two countries operate very differently. China is dependent on a healthy global environment for economic growth, whereas Russia’s energy-driven economic model means that it can withstand – and even benefit from – geopolitical upheaval. Militarily, an invasion of Taiwan would be much more complex than an invasion of Ukraine, given the complexity involved in crossing the Taiwan Strait and limited landing post.
Secondly, the cost – both economically and militarily – to China could be high, given the US’s relationship with Taiwan. Although it hasn’t been explicitly stated, there is a high probability that the US would defend Taiwan militarily. This is well understood at senior levels in the Chinese government.
The China-Taiwan issue is often thought of in binary terms i.e. whether an invasion will happen or not. However we believe there are a spectrum of eventualities, the majority of which involve a diplomatic solution.
How do you take this into account when investing?
We believe that the possibility of a Taiwan invasion is extremely low. Furthermore, as long-term equity investors, we are mindful of liquidity and the ability to exit positions in a timely manner. Remaining nimble is our best defence against geopolitical events.
We also believe that the friction between China and the US will continue, and on that basis, there are several companies that we choose to exclude from our portfolios. However, this is not an issue given that there are ~7,000 investable companies in the Chinese equity market index.
What is your view on de-globalization, a theme which seems to be gaining traction globally?
De-globalization is a very real trend and the impact on China will be negative, given its position as a strong beneficiary of globalization for the past two decades. However, the risk is more manageable than many think. The direction is set, yet it could take a significant amount of time to play out, and by the time it happens, China will have moved further up the global supply chain.
We also believe that China will remain an essential part of supply chains because of the richness of suppliers locally. Taking Apple as an example, nearly all of its products are assembled in China.1 It would take decades for the entire supply chain to be shipped elsewhere.
China is strongly interconnected with the global economy, it is the largest trading partner for most emerging markets, as well as markets such as the EU, and therefore a complete de-coupling is not possible.
Headwinds over the last few years, combined with lower economic growth for the years ahead, have made investors nervous. What gives you confidence, as a long-term investor in China equity?
Chinese growth has been supported by rapid industrialization, investment and urbanization. It can’t be denied that incremental productivity gains will be harder going forward, especially in the face of negative demographic trends.
On a more positive note however, Chinese GDP per capita is still significantly below other North Asian peers, such as Korea, Japan and Tawian, which suggests there is room to expand. This can be done through further improvements in education and urbanization, as well as expansion in value-added industries. There is still significant GDP upside in China, and with its role as the second-largest economy globally 2, it is still one of the most attractive markets. Also, as it transitions into a consumption-driven economy, the opportunities in this space are immense, with ~1.4 billion consumers.3
China is also well placed to lead on several thematics, such as EV adoption, green energy and technology developments that evolve around the domestic-substitution trend. These are important from an investment point of view.
Finally, Chinese financial markets are continuing to expand and allow for greater international participation. We believe that opportunities exist to generate more alpha, and especially for international investors.
1 'What to know about Apple and China,' The New York Times, June 17, 2021
2 'China's more balanced recovery gives support to global rebound,' Bloomberg News, July 14, 2021
3 'Chinese consumers wary of splurging after Beijing relaxes COVID strictures,' Reuters, December 11, 2022