A balanced picture emerges – Risk and reward in China

With investors enthusiastic about China’s recovery story, the country remains a long-term play thanks to consistent economic policies. Catherine Yeung, Investment Director, sat down with Fidelity International’s Andrew McCaffery, Global Chief Investment Officer; Vanessa Chan, Head of Asian Fixed Income Investment Directing; and Jing Ning, Head of China Equities, to discuss the tailwinds for growth, potential risks, and areas of opportunities. 

Key points: 

  • China will likely see steady and considered growth rather than a V-shaped recovery. 
  • Inflation likely peaked last year and is expected to be steady in 2023.  
  • The fundamental growth drivers of the Chinese economy remain domestic growth and improving momentum.  
  • With only 20 per cent of property bonds trading at distressed levels, the real estate market may be on the road to recovery.  
  • Affluent consumers appear to be bouncing back more quickly than lower-income homes.  
  • The PBoC has maintained liquidity and policy consistency.  
  • The attractiveness of the renminbi in 2022 could become more so this year.  
  • There is also a sense that business optimism is returning.  
  • Risks for investors include urbanisation, the increasing retirement age, and navigating the rapidity with which change has been implemented in China.  
  • In the equity market, valuations are below the historical average.  
  • The fixed income market is expected to deliver consistent total returns. 

What is notable about China’s emergence from the pandemic is that rather than experiencing a rapid V-shaped upturn, the country’s recovery has been relatively steady. “The government wants to build something that can be measured in quarters and years, not just months,” explains McCaffery. 

While much of the world faces significant inflationary pressures, China saw prices rise by only 2.1 per cent in January. “China is on a different path than other markets,” says Chan. Indeed, most of Fidelity’s analysts agree, with 88 per cent predicting business growth in China over the next 12 months. This compares to only 35 per cent who anticipate expansion among North American companies. The analysts also agree that global inflation peaked at the end of last year. “Labour and supply shortages are unlikely to be critical issues for Chinese companies,” she continues, adding that these factors have driven inflation elsewhere.  

Domestic recovery to lead the agenda

Recent geopolitical tensions are unlikely “to undermine the nature of the recovery in China and the focus on what’s happening within the domestic economy,” says McCaffery. Such factors or events influence international investors’ perception of risk premia, but it is more important to look at fundamental growth drivers and how the government plans to deliver a domestic recovery and build economic momentum.  

Recovery in the housing sector 

Turning to real estate, McCaffery observes how “We’ve already seen transactions that suggest the market is already healing.” Around 80 per cent of China’s property bonds were trading at 30 cents to the US dollar at the lowest point. That figure is now in the region of 20 per cent. Yet, the recovery has been slow. “The rest of the market is likely to take a little more time,” says Chan, adding that she will keep a close eye on events over the next few months. Furthermore, signs of economic stability should encourage people to return to the primary markets. “China wants a stable property sector, which will allow other parts of its economy to grow,” she concludes. 

Investor emphasis on consumption 

“The consumption and recovery story are probably the two most important things for investors to observe over the medium term,” says Ning. While growth will come from low, pandemic-induced levels, she believes it may be stronger than the market anticipates. 

However, it is worth noting that any rebound in demand may not be consistent. For instance, big-ticket consumer items like cars or home electronics could lag slightly. More to the point, affluent consumers will bounce back more quickly than those with lower incomes, given the wealth of the former is considered less macro-sensitive. It is also the case that some businesses are better prepared than others for increased consumption. “Many large, consumer-focused companies used the lockdowns as an opportunity to expand their franchises and capacity in the second half of last year,” she explains. And now that consumers are returning, these businesses are better prepared to absorb the increased demand than those in other sectors. 

Market liquidity, policy and business normality 

“I think the People’s Bank of China (PBoC) has managed quite well, especially when you consider how challenging some of the headwinds have been,” says McCaffery, citing the pandemic, regulatory change and geopolitical risk. The central bank has also maintained market liquidity and policy consistency. The renminbi's stability was attractive last year, and according to Chan, “the currency could look more interesting in 2023.”  

Regarding politics, all eyes will be on the 13th National People’s Congress (NPC), which begins its fifth annual session in Beijing on 5 March. Although the standing committee was announced in October last year, Ning points out that more clarity is expected in its policy framework.  

Given we are entering the corporate earnings season, she expects to hear the business community's views on the health of the broader economy. In addition, with an upturn in company events and business travel, the corporate world appears to be returning to normal. “The business community wants to make up the time it lost over the past few years,” she suggests.  

Risk awareness: longer working lives, urbanisation and the post-pandemic landscape 

The retirement-age debate in China and urbanisation are also critical issues voiced by Ning. The prospect of an extension to the working life for both men and women will be “a big surprise for many people.” Another factor to consider is urbanisation, particularly in lower-tier cities, which still has not run its course. For Chan, it is about balancing government policies, particularly those addressing structural issues, with economic balance and stability. Meanwhile, McCaffery recognises that investors may find it a challenge to navigate the rapid exit from the pandemic. However, he highlights an upside risk: some investors may realise too late that China could outperform other global markets. 

How should investors be positioned? 

Although a certain amount of positive news has been priced into the market, valuations remain around 10–15 per cent below the historical average. “This year is going to be balanced between growth and value,” says Ning, explaining that earnings expectations that had been depressed are now returning, and “risk versus reward looks promising.”  

Chan also observes that the fixed income market is expected to deliver consistent total returns, with sentiment “improving.” Although valuations are relatively tight in the Investment Grade market, she thinks the primary space is attractive. Elsewhere, investors in High Yield bonds should adopt a slightly longer-term view and consider the onshore market. More broadly, McCaffery notes that investors should be discerning about the names they buy, concluding that “any dips in relative performance present opportunities.”