2022 Investment Strategy Conference | Navigating Opportunities in China

It has been a very tough two years for stocks in China, with the MSCI China Index down by almost half since the end of 2020 . As a result, China is now one of the cheaper markets. On 2023 expected earnings, the MSCI China Index is trading at about 9x PE, compared to about 11x for the MSCI Emerging Markets Index and 14x for the MSCI World Index .

We have seen earnings expectations reduced meaningfully, but companies are still growing. This year has been challenging for the mainland economy, but corporate earnings are still expected to grow at close to 12% . Looking into 2023, the MSCI China Index’s expected earnings growth is about 19%, compared to 5% for MSCI World and 1% for MSCI Emerging markets .

Amidst so much chatter that China is “uninvestable”, the famous quote by the Oracle of Omaha Warren Buffett, “be greedy when others are fearful”, comes to mind. We think it is most apt for the current climate, and we still see a lot of value in China. Nonetheless, no one wants to catch a falling knife and China stocks have been weak for good reason, and so we would need to assess carefully whether conditions are showing concrete improvements.

Three broad themes have dampened expectations for China stocks, but we see improvements in each of these areas:

• Economic slowdown: Covid resurgences and the property crisis have weighed on the mainland economy. While we think the macro outlook remains subdued and volatile, we have seen some green shoots of recovery, such as in September when GDP growth exceeded expectations. Looking ahead to 2023, we believe that an improving policy outlook will support the economy.

• Lack of economic support: Periods of political uncertainty, such as an election for instance, tend to cause a policy stalemate in most countries. In the case of China, the country went through a major cabinet reshuffle this year with a lack of economic response leading into it. However, after the 20th Communist Party Congress in October resulted in a firming up of the country’s top leadership, we have seen Beijing switch tone to focus on the economy with a slew of encouraging measures. To us, the policy direction has clearly changed.

• Geopolitical concerns: The US-China conflict remains a pertinent concern, and we are not expecting warm and cosy ties. However, we do not think that the relationship has gone completely cold either, but rather that it has turned lukewarm because it is not in the interest of China, or the US, or the whole world for that matter, to have the two greatest powers embroiled in severe damaging conflict. The recent Bali Summit saw the Presidents of the two countries – Joe Biden and Xi Jinping – displaying a more pragmatic stance to the relationship.

We reckon that the environment will continue to be volatile, but we do think that the outlook for China is improving and there is still tremendous value for the potential growth that the country has to offer. At a time when the rest of the world, especially the US, is still inclined towards monetary policy tightening and as recession risks mount, we think China could prove a counter-cyclical bet into 2023.

Where then should we invest in China?

We prefer to take a longer-term view that considers the government’s overarching plan for the country including policy directions. There are more than 5,000 Chinese stocks, including both onshore and overseas listings, and we have identified five themes to filter that broad pool into a smaller investable universe.

1. Aspiration – the middle class continues to expand. McKinsey expects the number of Chinese households with an annual income above US$22,000 to increase by 68% from 2020 to 2030. There were already almost twice as many middle-class households in China than the US in 2020, and this will grow to three times as many by 2030, according to McKinsey’s projection. As affluence grows, both spending appetite and preferences change. We see sportswear brand Li Ning and beer company Budweiser APAC benefit from rising discretionary consumption, premiumisation of consumption, and normalisation of offline consumption as the Covid policy eases in China.

2. Digital – we expect the country to continue to advance on technology and innovation. This theme is not just about the increasing demand for digitalisation, but also the need for localisation and reducing external dependency. There are two sub-themes here:

a. Internet – we see great value in consumer internet, given that this market segment has fallen by close to 75% since the peak. We have some reservations around the growth potential because internet penetration is already high in China, which limits the revenue growth. However, valuations are cheap, the companies are still growing, and the cash flow is strong for the leading players – such as Alibaba, Tencent and JD.com.

b. B2B – digitalisation has advanced far more quickly on the consumer-facing front, such as the internet plays, but there is still plenty of room for better penetration and adoption on the B2B front. This includes software where we expect more Chinese companies to digitalise and adopt domestic software, which is cheaper and more customised to the local language and needs than foreign offerings; and robotics and automation where factories and warehouses are also modernising to improve operational efficiency. Some interesting names in this segment include Yonyou, Glodon and Shenzhen Inovance.

3. Green – China has made tremendous effort in the greening of the economy, such that blue skies that were once a rarity even in an advanced and coastal city like Shanghai are now more commonly seen. Its green transition has created giants that are able to compete on the global stage. China dominates especially in the production of solar modules and electric batteries where key names include Longi Energy and Contemporary Amperex Technology. New and attractive sub-themes continue to emerge as well, such as in energy storage and offshore wind energy.

4. Health – with rising wealth, we see a rise in affordability for premium healthcare, but at the same time also an increase in the more chronic lifestyle illnesses like diabetes. China’s ageing population also is another structural driver of healthcare demand. Healthcare spending as a percentage of GDP remains low in China relative to that of the developed markets, but we expect that to grow. Some notable stocks include Aier Eye Hospital, the leading private eye care hospital chain in the country, and Mindray, a leading medical equipment maker which is also seeing its overseas sales grow briskly.

5. Wealth – as China becomes more affluent, we anticipate a growing need for wealth management. This segment includes banks that are more retail oriented with large wealth management franchises like China Merchants Bank, and also insurers such as AIA Group, given that insurance penetration remains low. More broadly, China’s financial system is still under-developed relative to developed markets, with household wealth predominantly invested in property and cash. We expect that to change, which will in turn lead to more capital flowing into investment securities like equity and fixed income, and insurance. As a result, we are more positive on the onshore opportunity in the A-share market than overseas listings like the US ADR and H-shares over the longer term. Strategically, A-shares have also shown a much lower correlation to other markets, which means they merit a place in any diversified portfolio. That said, in the near term, we expect a stronger rebound for offshore China stocks listed in the US and Hong Kong if our positive view on China continues to play out.

In summary, we think it is a good time to explore China stocks because the outlook is improving and valuations remain cheap. We do not think China stocks are “uninvestable”, but it is beneficial to have eyes on the ground (for example, abrdn has investment teams in Hong Kong and Shanghai), know the language (given that government communications are all in Mandarin), and it is important to be vigilant of the direction of policies and regulations, just like in any other emerging market. Thus, we suggest taking a selective approach focused on Aspiration, Digital, Green, Health and Wealth, adopting a diversified stance, and having a longer-term view because emerging market stocks are generally more volatile than their developed market peers.