The re-opening trade in China has undoubtedly galvanised Asian equities, but how can investors position for the next move in markets? We review the current environment and highlights why recent market movements underscore the importance of disciplined stock selection to capture long-term value.
Key points
- Investors waiting for clear signs on the economic impact of re-opening in China would almost certainly have missed the bounce back and the early beneficiaries of the re-opening trade.
- China remains a significant source of investment opportunity, and we see consumption as an important long-term trend.
- Despite a rally in value stocks in recent months, they are still cheap compared to growth stocks. We appear to be at the early stages of long-term style rotation into value stocks.
The Chinese equity market has seen a buoyant and rapid rally following the government’s pivot late last year in its Zero-Covid policy. Investors quickly anticipated a resumption in normal patterns of economic growth and felt confident enough to reinvest in previously unloved parts of the market – namely the beneficiaries of re-opening.
However, investors waiting for clear signs on the economic impact of re-opening would almost certainly have missed the bounce. Companies most affected by the lockdowns – such as retail, leisure and travel stocks – rallied quickly. Investors looking at many of those stocks today will find that they already fully discount the earnings boost from re-opening, despite the recent pull back in the market.
Long-term beneficiaries
The reality is that investors needed to be in these areas before the government took action. For our valuation aware strategies, this led us to some of these re-opening beneficiaries ahead of time. For example, restrictions on travel and strict lockdowns had seen valuations of some online travel-related and luxury-goods companies fall, and we saw the potential to pick up long-term structural growth at a discounted valuation.
Careful stock selection and buying high quality companies when they are out of favour or overlooked by others can help position for structural changes ahead of time. This has worked well during this period of recovery.
Value still cheap
The question for us today is where to look next, as we rotate the capital taken from profits into opportunities elsewhere. There are fewer obvious valuation opportunities and we need to be highly selective and nuanced in our stock selection.
Value stocks in Asia still look cheap relative to growth. While 2022 saw some rotation from expensive growth companies to cheaper value companies, this appears only the initial stages of a wider mean reversion. In fact, what we are witnessing now is somewhat similar to 2000 when smaller growth stocks were trading at an all-time high premium to smaller value stocks – even though these growth stocks hadn’t delivered better earnings over the two decades before. Notably, since 2000, small-cap value stocks in Asia have grown earnings faster than their growth counterparts.
Structural growth opportunity
At a country level, China remains a source of opportunity. Chinese consumption is still an important long-term trend and there is pent-up demand to be realised. After strict lockdowns, Chinese people want to meet, travel and spend money. It is also worth noting that household savings rates in China have gone up over the lockdown period, so there is a substantial amount that should be channelled into the economy over the next few months. Growing the consumer side of the economy also remains a key priority for the Chinese government, as is the recovery in the domestic property market. If we start to see a recovery in the property segment, we could get yet another boost for the earnings environment.
For our value-driven strategies, our focus has always been on finding good businesses, run by a strong management team, at a margin of safety (good valuations). Invariably, there will be those companies that disappoint and others that will exceed expectations in this new environment. We ensure that our positions are led by the reality of a company’s position and whether that is reflected in its valuation.
