Volatility in China conceals pockets of strength

It’s been a weak start to the year for China and Hong Kong stocks, with the CSI 300 falling 6.2 per cent and the Hang Seng index down by 12.2 per cent in January. These moves follow the People’s Bank of China’s decision to maintain rather than cut prime loan interest rates, indicating a reluctance to inject additional stimulus into the economy amid further concerning economic data. 

The fast-paced sell-off has led to a sense of panic. Investors have rushed to sell more to maintain underweight positions in China and adhere to volatility controls, further undermining confidence. 

Why there was no stimulus bazooka

A repeat of previous bazooka-style stimulus is unlikely since it would undermine the government’s long-term economic objectives. China's economic cycle has diverged from the West’s, where inflation concerns have led central banks to maintain high interest rates, constraining growth momentum. In contrast, the Chinese government is slowly but surely stimulating investment and consumption to achieve stable GDP growth of around 5 per cent. 

But despite ongoing economic challenges, targeted support for the property market and a shift in policy orientation towards growth have set the stage for recovery. Moreover, the substantial levels of household savings, accumulated for security during these uncertain times, creates the potential for an upswing in consumer spending once confidence is restored.

Compelling valuations 

While it’s too early to declare an end to the move in equity markets, long-term investors should find comfort in the resilience and adaptability of Chinese companies. Their commitment to innovation and high-end manufacturing is evident in measures of R&D spending and their share of global patent applications. 

Valuations now look compelling too. The one-year forward price-earnings ratio for the MSCI China index is 9x versus its 10-year average of 11.4x - not far from its lowest level in the past 20 years. 

Good quality companies will profit from gaining market share in fragmented industries like building materials, which are poised for further consolidation. Urbanisation and a growing middle class continue to strengthen consumer purchasing power, offering structural growth for those under-penetrated products and services industries. 

Look beyond the headlines

Fidelity’s on-the-ground research points to ongoing growth in pockets of the market such as healthcare, especially in areas with low penetration like medical devices or core pharmaceuticals. Similarly, our research highlights emerging sectors such as the electric vehicle value chain, particularly those companies providing key components and services, like battery manufacturers or auto parts suppliers. Many businesses are also benefitting from the re-orientation of global supply chains and an increasing focus on self-sufficiency and local suppliers.

Recent market action has been unsettling, but it usually pays to think beyond the emotion of the moment and, as always, focus on fundamentals.