Market Insights | The Sleeping Dragon’s Slow Awakening

By Cornelius Zeeman,
Fairtree Portfolio Manager

The Chinese equity market exhibits subdued performance.

 

The Chinese equity market has been range bound this year. In contrast, the US market has continued its recovery, which started in the last quarter of 2022 – bringing the US equity market outperformance in touching distance of 100% over the last 5 years, while the Chinese relative underperformance started in 2021 when the Chinese Government continued with their draconian lockdown measures and the rest of the world went back to normal. During this period, the Chinese Government also clamped down on the Technology sector and private enterprises through various measures, including limiting game time for minors, essentially banning private online education, and handing out fines to the likes of Ant Group. These actions scared away Western investors, with many calling the Chinese market ‘uninvestable’ and raising the hurdle to attract back investors. Investors want real evidence of economic growth, which creates an environment for earnings growth and shareholder returns.

Graph 1: Index Returns (based to 100)

Source: Fairtree, Bloomberg

China’s economic reopening has disappointed.

 

Although the Chinese Government lifted Covid-19 restrictions towards the end of 2022, they did not support the economy with significant monetary or fiscal stimulus delivering a muted Chinese economic recovery versus the case studies we have seen in the West over the last few years. 

Most Chinese Household Wealth is invested in Residential Property, and the fact that property prices have come under pressure over the last two years has had a major impact on Chinese Consumer Confidence (see Graph 3). The Government has been hesitant to support this market because it has fuelled risk-taking behaviour, leading to pricing bubbles and financially troubled Property Developers. Beijing is unwilling to jeopardise long-run stability to generate a short-term upswing. As such, policymakers have adopted a more reactive policy response function.

Graph 2: Chinese House Price Diffusion Index (m.o.m)

Source: Fairtree, Bloomberg

Graph 3: Chinese Consumer Confidence

Source: Fairtree, Bloomberg

The weak Chinese Consumer Confidence (see Graph 3 above) is impacting Retail Sales, which have continued to trend lower. Concerningly, China decided to stop publishing Consumer Confidence data in April. It is not unique for China to stop publishing data when it shows the economy is faltering. In June, the jobless rate for 16- to 24-year-olds in urban areas hit a record high of more than 20%, and they announced today that they would pause the publishing of this data till they have “ironed out complexities in the numbers”.

Graph 4: China Retail Sales Growth (y.o.y)

Source: Fairtree, Bloomberg

The Industrial side of the economy has turned negative if we look at the Chinese Manufacturing PMI numbers (see Graph 5 below) that keep dipping below 50, which means negative growth. The fact that many countries want to diversify their supply chains away from China does not bode well for this pocket of the economy over the medium term. China’s July CPI and PPI inflation release indicate that deflationary pressures dominate the domestic economy. After remaining unchanged in June, consumer prices fell by 0.3% y.o.y. Meanwhile, the 4.4% y.o.y drop in producer prices marks the 10th consecutive month of decline.

Graph 5: Chinese Manufacturing PMI

Source: Fairtree, Bloomberg

Chinese credit and money data fell significantly below expectations in July. The CNY 0.53 trillion increase in aggregate social financing marks a significant slowdown from CNY 4.22 trillion in June. Subdued credit growth is the latest in a string of disappointing Chinese economic data releases including contracting imports and exports. The export contraction deepened to -14.5% y.o.y in US dollar terms in July, while imports dropped -12.4% y.o.y. The weakness was broad-based across China’s major trade partners.

Contagion risks are appearing.

 

One of China’s largest private wealth managers, Zhongzhi Enterprise Group Co., is triggering fresh anxiety about the health of the country’s shadow banking industry after missing payments on multiple high-yield products. Zhongzhi ($138bn AUM) is among the biggest players in the country’s $3 trillion trust industry. Zhongzhi’s trust unit bought stakes in real estate projects last year, betting on a market rebound that has so far failed to materialize. Investors are already on edge over concern about the health of China’s economy and financial markets. One of the nation’s largest developers, Country Garden Holdings Co., is on the brink of default.

The question for investors going forward is whether the latest round of economic data and risks have pushed policymakers to the limit of their economic pain threshold and will cause them to intensify their efforts to stimulate the economy more meaningfully.

Latest government actions.

 

China has followed a conservative approach to easing monetary policy. The People’s Bank of China (PBOC) cut the reserve requirement ratio (RRR) by 25 basis points (bps), effective March 27th. The reduction follows a 25-bps cut for all banks in December. During June, the PBOC cut its seven-day reverse repurchase rate from 2% to 1.9% – the first cut in nine months as the economy lost momentum and hard data started to disappoint. They followed this up by cutting another 10bps today. The PBOC also cut the rate of the one-year medium-term lending facility (MLF) by 15 basis points from 2.65 to 2.5%. The speed of monetary easing is clearly picking up.

Recently the Politburo started softening their stance, as they removed a key phrase from the readout of its meeting in April meeting, that cited President Xi Jinping as saying, “Houses are for living, not for speculation”. China’s NDRC (National Development and Reform Committee) has announced a series of measures to boost consumption. “Boosting consumption is the key in stimulating recovery and expanding demand,” said Li Chunlin, deputy director. Some items to highlight include:

  • Expanding New Energy Vehicle consumption. 
  • Upgrading consumption of home decoration, home furnishing and electronics products. 
  • Expanding food service consumption.
  • Expanding consumption with digital tools. 

These subsidies and government actions will boost consumption, which bodes well for Consumer Technology companies in China. Some of these companies are trading on low teens Price/Earnings multiples due to the negative sentiment. These companies have cut headcount and costs over the last year, which means we can see both an acceleration of sales growth as well as margin expansion. This bodes well for listed e-commerce companies like Alibaba, JD.com and Pinduoduo.

Disclaimer: 

This article is based on available data and does not constitute financial advice. Investors should conduct their own research and consult with a financial advisor before making any investment decisions.

Fairtree Asset Management (Pty) Ltd is an authorised financial services provider (FSP 25917). Collective Investment Schemes in Securities (CIS) should be considered as medium to long-term investments. The value may go up as well as down and past performance is not necessarily a guide to future performance. CISs are traded at the ruling price and can engage in scrip lending and borrowing. A schedule of fees, charges and maximum commissions is available on request from the Manager. A CIS may be closed to new investors in order for it to be managed more efficiently in accordance with its mandate. Performance has been calculated using net NAV to NAV numbers with income reinvested. The performance for each period shown reflects the return for investors who have been fully invested for that period. Individual investor performance may differ as a result of initial fees, the actual investment date, the date of reinvestments and dividend withholding tax. Full performance calculations are available from the manager on request. There is no guarantee in respect of capital or returns in a portfolio. Prescient Management Company (RF) (Pty) Ltd is registered and approved under the Collective Investment Schemes Control Act (No.45 of 2002). For any additional information such as fund prices, fees, brochures, minimum disclosure documents and application forms please go to www.fairtree.com

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