China and the post Covid era

Since the Chinese government dramatically rolled back its Covid restrictions, the country’s stock markets have bounced. Are investors right to be more enthusiastic? By Nicholas Yeo and Elizabeth Kwik

• The Chinese government has dramatically rolled back its Covid restrictions
• There will be some short-term pain, but the Chinese economy is now recovering
• The property sector is also seeing green shoots of recovery

 
China has made an unexpected and rapid retreat from its zero-Covid policy. From November last year, the government has dramatically reopened its economy, rolling back the restrictions that have been in place for the last three years. The country’s stock markets have bounced in anticipation of stronger economic growth. Are investors right to be more enthusiastic?

The immediate aftermath of the end of zero-Covid has been difficult. With low herd immunity, the infection rate has shot up. Major cities such as Beijing and Shanghai have borne the brunt of the infection surge, but this is now spreading to rural areas. Hospitals remain under pressure and tight on manpower, but – for the time being – not on the brink of collapse.

However, there are signs that the situation is improving. After an initial decline, people have started to travel once again. The population is generally supportive of the government’s action, pleased that the onerous restrictions are at an end. There are signs of recovery in consumer spending, in travel and tourism, and on leisure activities. There has been pent-up demand, which is now moving out into the real economy.

Ultimately, our view was that the easing of measures was necessary. While the rapid pivot has taken many by surprise, concerns over the state of the economy had been mounting. It had proved extremely costly to run a zero-Covid policy. It had hurt exports and China risked being permanently excluded from global supply chains as companies moved production elsewhere. There were protests on the street as citizens signalled their mounting displeasure at the policy.

The government appears to have decided that any short-term pain will be worth the long-term economic recovery. Either way, we believe the policy is now firmly established and will not be reversed.
 

Real estate reversal

 
The other factor that has held back Chinese markets is the property sector. The Chinese authorities had become increasingly conscious of the potential systematic risk on the over-indebted real estate market and took action to curb lending. This has led to some well-publicised distress in the sector for groups such as Evergrande.

More recently, the tone from the government and regulators has changed. They are seeking to deflate the market, but maintain support to better quality developers. They have introduced some flexibility on lending – if property prices are on a downward trend in a particular city, banks are allowed to offer lower loan rates or drop deposit requirements. On balance, the move from a largely unregulated ‘Wild West’ market with few regulations to one where there is a lot of oversight is welcome for Chinese economic stability.
 

Our focus

 
This is a more benign backdrop for investing in China and we are starting to see value being appreciated by investors. However, at abrdn China Investment Company, we believe it is important to focus on key themes, working with the grain of government policy rather than against it.

One of the key themes in the trust is “aspiration”. Rising affluence is generating fast growth in specific “premium” sectors within food, travel and cosmetics. There is a rising middle class with increasing wealth and an appetite for top tier brands.

We are also seeing widespread adoption of technology. In the trust, we have exposure to areas such as e-commerce, cybersecurity and data centres. Many of these companies are also the beneficiaries of a drive to localisation in the face of growing national security considerations. There is a push from government to use domestic providers.

Chinese policymakers are increasingly committed to the green theme, with pledges on lower carbon emissions and the move to renewable energy. In particular, we have found opportunities for the trust in the renewable energy supply chain, such as related infrastructure and battery production.

Other themes for the trust include healthcare, where we see a rising demand for products and services. Our holdings are diverse, including a leading eye hospital, contract research provider and internet healthcare platform. We also focus on the wealth management segment, with increasing investor participation on stock exchanges, plus life insurance providers. At the moment, this is very under-penetrated in China.

Overall, our focus is on finding quality companies – those with a sustainable competitive advantage in an attractive industry, with a strong management team and defendable margins. We believe this is particularly important in China and particularly important today. It means there are fewer tail risks and a greater margin of safety. We want to find companies with less volatile earnings streams, that are more resilient through the economic cycle. This gives us greater confidence that the companies we hold can navigate the occasionally complex politics within China.

The Chinese economy is reopening and starting to recover. Valuations are low relative to their global peers and the country has side-stepped the worst of the global inflationary pressures that have hit elsewhere. It is an interesting moment to be re-evaluating China.