Need to know: China’s economy appears to be stabilising, yet we believe the government needs to do more to support growth in the short term In our view, the Asia ex Japan equity investors should still allocate to China, but they need to be more selective there   We outline the sectors we like most in China, as well as our policy wish list

The Asian countries we favour in 2024 – India, Indonesia and the Philippines – have the strongest macro outlook in the region. By contrast, we remain slightly underweight in China for this year¹. We discuss the reasons why, and our policy wish list for China, in the latest insight from our Asia equities outlook series.  
 

Stabilising and transitioning 

Most economists got it wrong with China’s Covid reopening. The initial spur quickly gave way by Q2 2023, with disappointing macro news of slower consumption, trade data and inflation. Rather than spend, Chinese households chose instead to be more prudent in their consumption, opting to pay down mortgages in light of a languishing property market and decreasing job security. 

We believe that Chinese policy makers will not tolerate a rapid slowdown in the economy, as evidenced by the flurry of support measures announced lately. The recent increase in the budget deficit sends a strong signal that top policy makers remain on track to support growth, albeit slower growth compared with pre-Covid levels. 

Our view is that China’s economy is showing signs of stabilisation, and policy makers are willing to implement coordinated and incremental stimulus. Such policies take time to work through the system. We think those announced so far have led to some improvement, as reflected in the chart below showing the growth trend for the fixed-asset investments (FAI) in manufacturing and infrastructure. We can see that the real estate FAI remains weak, but we like to highlight that China’s property value to GDP ratio remains low at 0.4x vs 0.7x in Japan and US property peaks. 

FIG 1. China FAI sector breakdown

Source: BofA Global Research, CEIC, NBS.
 

A more selective allocation 

The size of the Chinese economy today is USD 17.8 trillion, roughly 4.8x larger than India’s. Assuming China’s growth slows to 2% per year for the next 10 years and India grows 10% per year over the same period, China’s economy would still be 2x larger than India’s. Therefore, our argument is that when investors look at Asia ex Japan equities, they still need to allocate to China but should be more selective there. 

FIG 2. Top 10 global economies

	GDP 2023 (USD billion)	GDP/Capita 2023 (USD thousand)
US	26,954	80.4
China	17,786	12.5
Germany	4,430	52.8
Japan	4,231	33.9
India	3,730	2.6
UK	3,332	48.9
France	3,052	46.3
Italy	2,190	37.2
Brazil	2,132	10.4
Canada	2,122	53.3

Source: IMF, Forbes India as of Dec 4, 2023.
 

China requires active stock selection

2024 would mark the fourth year of consolidation for Chinese equity markets since the peak in 2021. The Asia High Conviction strategy is currently slightly underweight Chinese equities¹, as we believe the government needs to do more to support growth in the short term, and this would affect both the currency and the economy. 

For the CNY, we think the depreciation against USD may not be entirely over even as the US cuts rates, as there is still a significant yield gap. We are also of the view that there will be incremental policy supports with looser monetary conditions at least into Q1 2024. However, we have also seen the central bank intervene to stabilise the CNY, thereby putting a floor on excessive depreciation. As we move through 2024, we should see more signs of economic improvement and a possible appreciation of the CNY towards H2. 

The capital markets would pretty much reflect the broader economy. Our base case assumes that policy support would only remain incremental, but the economy would stabilise. With this backdrop, we believe that China’s equity markets require active management, as the market indices may not perform but the right stock-picking would. 

We are most positive on companies that have a global or going-global orientation, beneficiaries of US rate cuts and stocks that promote self-sufficiency in tech hardware. 

Chinese consumer companies including PDD Holdings, Miniso Group and Pop Mart International² are gaining traction outside their home market, proving they are able to understand and adapt to the taste of global consumers. Broadening the consumer space, Shenzhou International² – an apparel manufacturing powerhouse serving global brands like Uniqlo, Nike, Adidas and Lululemon² – is among those improving production efficiency. Techtronic², a Hong Kong company that supplies DIY tools to the US market, would prove to be a US housing beneficiary. Lastly, it is worth remembering that Lenovo², the Chinese PC maker, derives 75% of its revenue from outside China. 
 

REITs, clean energy

With the potential for US rate cuts, we believe there could be opportunities again in high dividend yield stocks and rate cut beneficiaries. There may also be some opportunities in the property sector in Hong Kong/China. We are not advocating a big bet here but believe the sector is oversold at the moment, and potential rate cuts and any policy surprise would be sufficient to trigger a tactical rally. 

We also like REITs, which saw their dividend yields rise to above 6% due to US rate hikes. Some of the REITs have very strong rental assets in both Hong Kong and China and could potentially re-rate as investors begin to move away from holding cash. 

Another rate cut beneficiary would be clean energy. Stocks in this space have been sold off immensely since peaking in early 2021. The iShares Global Clean Energy ETF (ICLN US) has been one of the worst-performing ETFs amid the rise in interest rates, losing over 50%. However, with US rate cuts, the returns of the clean energy project would improve as financing costs decrease. We believe the clean energy transition is an ongoing, long-term trend that may suffer occasional hiccups when the economics prove infeasible. China is globally the most cost-efficient producer of raw materials and parts for clean energy. 

The picks in self-sufficiency tech hardware coincide with our picks in the tech hardware sector in Korea and Taiwan, where these companies are able to supply to Chinese customers. 
 

China valuation 

The valuation in China remains near all-time lows. The P/BV stands at 1.1x versus the historical normalised valuation of 1.6x, representing a potential upside of 45%. Of course, we do not believe that China can trade back to its normalised valuation of 1.6x in the medium term as the economy undergoes this adjustment period. 

We summarise the Chinese equity markets using the Chinese word ‘crisis’, which is 危机 (pronounced wéijī). When the characters are taken individually, 危 means danger while 机 is opportunity. Fittingly, we believe that in these times, one has to be opportunistic (active management) when investing in Chinese equities.
 

Our wishlist

We like to end our discussion about China on a positive note, with a wish list. Some of these policies could include:

1. Fiscal policy support via increasing the deficit ratio, as in 2023
2. Property sector support, e.g., removing the home purchase restriction in tier 1 cities, confirmation of a ‘whitelist’ of 50 property developers
3. Additional assistance to solve the local government financing vehicle (LGFV) debt risks 
4. Capital market support similar to what happened in Hong Kong in 1997, when the government spent USD 15 billion in one month to buy all 33 constituent stocks of the Hang Seng Index, which was then gradually put back onto the market via the launch of the Hang Seng Tracker Fund (2800 HK) 
    

Although we believe the likelihood of our wish list materialising is low, we are confident that there will continue to be incremental policy adjustments to support growth. 

In the meantime, our slight underweight remains, unless one or more of our wish list measures are implemented and confidence returns to the market.


1  Allocations are subject to change.
2  Any reference to a specific company or security does not constitute a recommendation to buy, sell, hold or directly invest in the company or securities.

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