- Ratings downgrade
- EV exports growth
It already feels like a long time ago that the Chinese dragon was roaring. Foreign investors are fleeing the world’s second-largest economy, with the country embroiled in issues ranging from a property market slump to record youth unemployment. This is all contributing to a highly uncertain outlook for 2024.
The latest news for those who retain the faith hasn't been promising. Credit rating agency Moody’s cut its outlook on China’s government credit rating from stable to negative in December, pointing to “increased risks related to structurally and persistently lower medium-term economic growth and the ongoing downsizing of the property sector”. Elsewhere, manufacturing activity has fallen for two months in a row and industrial growth has slowed.
At the start of 2023, the hope was that the belated reopening of the Chinese economy, onerous coronavirus restrictions having been lifted at the end of last year, might provide a lift. But the post-pandemic economy has stuttered rather than surged, and international investors have acted with their feet. Morningstar data suggests that outflows from China funds amounted to more than $7bn (£5.6bn) in the third quarter. One measure of foreign direct investment, meanwhile, turned negative this year for the first time since records began in 1998.
The problems facing the economy are well known by now. The bursting of the debt-fuelled property bubble, encapsulated by the dire positions of developers Evergrande and Country Garden, has brought liquidity headwinds for manufacturers and shattered wider confidence. Ongoing woes in the sector, which makes up around 30 per cent of China's economy, look set to cause further serious damage.
There is also growing unease about investment risks stemming from government regulation and intervention, with medical and pharma shares hit this year from a state crackdown on "corruption", following on from clampdowns on the likes of education and technology companies – albeit the stated reason in those cases was structural reform, not corruption – in 2021.
The year ahead
Deutsche Bank chief China economist Yi Xiong says of current prospects: “China’s cyclical rebound still hasn't happened yet, primarily because after a prolonged property sector downturn and a sharp drop in inflation, a vicious loop has emerged among consumer spending, business profits, and their forward expectations for income and prices. A positive shock is required to break the loop. Only the government can jump-start the economy through forceful and coordinated policy responses.”
In the absence of this kind of action, it has been a bad time to be an investor in Chinese equities. The CSI 300 index, which includes the largest 300 companies on the Shanghai and Shenzhen stock exchanges, is down by a third on a three-year basis. The broader MSCI China index has fallen by almost 40 per cent over the same period.
While the Chinese market has underperformed as a whole, there are also sector-specific issues to consider. We flagged earlier this year how dividends at miners such as Rio Tinto (RIO) and BHP (BHP) are exposed to a weaker Chinese economy and its impact on iron ore prices. Trade headwinds also continue to cause problems – ecommerce business Alibaba (HK:9988) cancelled plans for a separate listing of its cloud business because of the US taking action on AI chip exports.
It's not all doom and gloom, though. Chinese equities now trade at heavily discounted valuations, which means there are cheap opportunities on offer for those who can stomach the risk. The Baillie Gifford-run Pacific Horizon (PHI) investment trust has significantly increased its exposure to China with this in mind, its top 10 holdings including Ping an Insurance (HK:2318) and Zijin Mining (HK:2899).
There is no doubt that Chinese companies can still have a sizeable impact on world markets. The energy transition is the latest focal point; in the electric vehicles (EVs) space, companies such as BYD (HK:1211) and Nio (HK: 9866) are bumping up exports as their pricing models undercut Western competitors. The EU has launched an anti-subsidy investigation in reply. EV sector progress is also helping Western expansion prospects for the likes of battery manufacturer CATL (CN:300750).
UBS analysts, who are bullish on BYD, say the company "is well positioned as the volume and margin leader in China's EV space" and added that "potential re-rating catalysts include volume expansion and product mix improvement from the export pipeline and premium brand rollout".
While the relative cheapness of Chinese equities has got some asset managers interested, a lot arguably depends on whether China can deliver on its 2024 GDP growth forecast, which is yet to be set out. The analyst consensus, according to FactSet, is for expansion of 4.5 per cent. This would be well below the 5.2 per cent expected for this year and represent a serious headache for an economy that was used to growth rates of over 6 per cent in the years leading up to the pandemic.
Carmignac portfolio adviser Kevin Thozet argued earlier this month that even a stabilisation of economic growth “would be sufficient to see a potential strong recovery in Chinese equity markets”. Much of this will be down to how much stimulus and support the Chinese state is willing, and able, to offer. Beijing has shown itself ready to prop up the economy over the past decade, but there are suspicions that president Xi no longer views this as such a priority.
Thozet's colleague at Carmignac, chief economist Raphaël Gallardo, thinks that a Chinese growth acceleration in the second half of 2024 "requires the leadership to abandon its gradualist approach for a strategy combining a restructuring of all housing-related debts... nationalisation of losses, bank recapitalisation and consumption stimulus. Such a policy quantum leap remains elusive for political reasons".
