Last quarter, the Shanghai A-share Index did 11 per cent better than the S&P 500 and 15 per cent better than the MSCI Emerging Markets Index. Still, sentiment on China is gloomy. The negativity is fuelled by large amounts of bad news.
Western entrepreneurs and investors are wondering whether they should withdraw from the country as tensions mount in Taiwan. A crisis in Taiwan could lead to investments being stranded or written off - as happened with Russian assets after the invasion of Ukraine - and to chaos in the supply chain on a much larger scale.
According to Nicholas Yeo, head of equities in China at asset manager abrdn, withdrawing from China is not an option for investors. The country offers great opportunities, he said. “There is a lot going on in China, but Taiwan is not the biggest problem as Western headlines suggest,” said Yeo, who manages the China A Share Sustainable Equity Fund from Hong Kong.
Taiwan
“China is not at all ready for a conflict, that would mean years of economic stagnation. The last thing the Chinese government wants is a conflict while the 20th Party Congress of the Chinese Communist Party is coming up this autumn,” said Yeo.
The Chinese government previously announced its intention to pursue a stable and market-friendly policy in the run-up to the congress, which takes place once every five years. The congress is the public occasion for top-level political changes within the Communist Party of China and the formal event for amendments to the party’s constitution.
Covid
According to Yeo, investors should focus on risks surrounding the Covid-19 situation and the “mortgage boycott”. On Monday, the country cut interest rates on one-year loans to banks by 10 basis points following disappointing economic data and rising Covid cases. The decision underscored growing concerns in Beijing, which is trying to counter a months-long drop in consumer demand, partly caused by strict Covid policies and cash-strapped property developers.
The long lockdown in Shanghai caused a sharp contraction in economic growth across the country, “but that is probably over”, he said. According to Yeo, the Chinese government did learn from that experience.
A “mortgage boycott”
Another problem in China is the increasing number of people who refuse to pay their mortgages, as property developers are in danger of running out of money.
Chinese people usually start financing the mortgage before the house is finished. Strictly speaking, the payments must be used to finish the building project, but many developers have been using the money to finance new projects for years.
“Because many developers are currently unsure whether they can complete the projects”, said Yeo, “mortgage holders refuse to pay the mortgage, which is usually paid in advance or redeemed before the project is completed. This has become a social problem where the government has to intervene.”
“Banks will be urged by local governments to ensure the financing of the projects. The abuse by property developers is pulling down the whole Chinese economy,” Yeo said. “The government will now have to partially de-leverage the property market as happened to American banks during the crisis in 2008. The moral hazard must eventually be cut out of the system.”
The opportunities
“China is a catapult that is now being pulled up to tension,” said Yeo. “But it doesn’t take much for the country to shoot out of the starting blocks.” He added that “Due to the large amount of negativity, shares are attractively priced. Inflation is still low at 2.7 percent, and so the government can pursue a looser monetary policy than in the West.” He said that all the conditions are in place for a rising stock market in the long term.
“The number of households with disposable incomes above $20,000 is expected to increase by 70 per cent over the next decade. This will greatly encourage the consumption of more expensive consumer goods, such as shoes, cosmetics and high-quality alcoholic beverages. This so-called ‘aspirational consumption’ is rising fast.”
In addition to aspirational consumption, abrdn looks at four structural themes in China: digital, green, healthcare and wealth management. Digitalisation in particular, driven by national security interests, is an interesting trend as far as Yeo is concerned. China does not want to use American software and hardware. That means, for example, a huge push for local, government-backed software and semiconductor products, which the Chinese are now bringing back from the West in large numbers.
China A Share Sustainable Equity Fund
Abdrn’s China A Share Sustainable Equity Fund (ISIN: LU1130125799) is set for a negative performance of 13.64 per cent after expenses for 2022, sitting short of the performance of the MSCI China A Onshore Index. The fund’s annualised five-year return stands at 12.07 per cent after costs. The benchmark has a five-year annualised return of 5.25 per cent. The portfolio amounts to $3.3 billion, has 40 companies and a Sharpe ratio of 0.41.