Macroeconomic malaise, gloomy growth outlook

Chinese stock markets have had a rocky start to this year. In spite of a bleak macroeconomic backdrop, China has set an arguably ambitious GDP growth target of 5.5% for 2022.

Our Research Institute thinks they’re unlikely to hit that. We released a below-consensus GDP forecast for 2022, which the tough start to the year seems to uphold. While we anticipate that China will have a better year than 2021, there remain some headwinds on the horizon:

1. Zero Covid

It’s widely acknowledged that China managed the initial stages of the global Covid-19 pandemic well, containing outbreaks. However, the advance of the more transmissible Omicron variant sparked strict domestic lockdowns as authorities stuck to their “zero-Covid” policy.

The most recent outbreaks have impacted provinces that collectively represent about one-third of China’s GDP. So it’s difficult to rule out further disruption to economic growth as the year progresses.

2. Regulatory pressures

Last year severe regulatory ructions in China spooked investors and caused market disruption. This process is still playing out, particularly across real estate. However, we don’t think the impact from regulatory crackdowns will be as heavy this year as it was in 2021.

The broad property sector, which was severely affected by the shifting regulatory perimeter, accounts for some 30% of China’s GDP. In other words, the sector remains integral to the nation’s growth outlook.

The question is: will Chinese authorities be able to restore the real estate sector to firmer ground and so engineer a softer landing for the economy?

Some figures still look alarming. The value of buildings sold was down 26% year-on-year in March, while new sales are down 22%.[1] But year-on-year comparisons can be misleading. Activity levels relative to seasonal norms show an improvement in sales since October and point to a tentative stabilisation in new construction. Moreover, while a “big bang” stimulus is incompatible with de-risking real estate, we have seen a drip-feed of smaller policy measures – indicating the worst may be behind us.

Markets have also had to digest:

1. Equity de-listing
While this isn’t as noteworthy as the two macroeconomic factors outlined above, this year the US Securities and Exchange Commission (SEC) included five Chinese ADRs[2] on a list of companies that it may de-list. This contributed to a significant market sell-off in March. We were surprised by the strength of the market reaction as de-listing pressures are nothing new.

By way of preparation, the ADRs have already initiated secondary listings in Hong Kong. At a government level, China is still talking to the US about access to some audit papers for companies in question, meaning they may be able to avoid de-listing. It’s hard to see this as a persistent headwind.

2. The war in Ukraine and China’s relationship with the West
In February – before Russia invaded Ukraine – China and Russia announced a “no-limits” partnership. This places additional strain on China’s relations with the West, calling into question China’s attempts to position itself as neutral.

Siding with Russia could have adverse economic consequences. Trade between the US/EU and China is 20 times that between China and Russia. Russia’s economy is the same size as that of Guangdong province. It suggests China won’t put all of its eggs in a Russian basket as it strives to grow its economy. Our Research Institute has forecast that China will become the world’s largest economy by 2033.

Long-term opportunities remain

We remain positive about investing in quality Chinese stocks over the long term. Market volatility this year appears to be based more on prevailing sentiment than fundamentals.  

In November 2021 and March 2022, Covid lockdowns sparked sell-offs in China’s consumer discretionary sector, for example, while sharp regulatory shifts hit health-care stocks late last year.

Not only are quality companies more likely to withstand market downturns, they have become relatively cheap. China’s equity market is trading way below its historical average. Further, consensus forecasts for company earnings growth stand at a respectable 14%.

We see companies in these five investment segments as best positioned for growth:

1. Aspiration
We expect China’s vast consumer market to grow 400% to $30 trillion by 2050 (see chart 1). This could create huge demand for premium services and higher-end goods, both foreign and domestic.

Expanding premium consumer class

2. Digital
China needs to import about $280 billion worth of high-end semiconductors to meet demand and is spending a lot on local production. The on-shoring of semiconductor manufacturing presents compelling investment opportunities.

We also see opportunities in software. Many sectors are digitising to meet innovation targets. As such, companies providing digitised services are potentially in line to benefit.

3. Green
China has set an ambitious goal of carbon neutrality by 2060. We’ve explored the opportunities of this theme and this goal before, but it bears repeating. China relies heavily on oil and gas imports from overseas. Going green would enable China to become energy independent and free of the burden of imports. This creates a myriad of potential investment opportunities around clean energy.

4. Health
China’s population is ageing, with a median age of 37 likely rising to 47 by 2045. But it isn’t just ageing – it’s getting wealthier. This suggests that demand for healthcare services will grow exponentially over time, presenting long-term investment opportunities.

5. Wealth
A wealthier population points to more people looking to protect their wealth for future generations. We believe well-managed, privately run banks will be best positioned to cater to their needs and so offer good investment potential.

In summary, we know China will continue to make headlines in 2022. But in spite of recent stock market shake-ups, there are fundamentally driven, thematic, long-term opportunities that investors would do well not to overlook.

[1] Bloomberg, April 2022

[2] An ADR, or American depositary receipt, is a negotiable certificate issued by a US depositary bank representing a specified number of shares of a foreign company's stock. The ADR trades on US stock markets. They offer US investors a way to purchase stock in overseas companies that would not otherwise be available.

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