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As the investor community considers the possibility of economic recession, China is once again proving to be ahead of the curve.
Economic activity, the regulation of tech companies, geopolitical and political worries, the real estate market – all indicators are in the red, suggesting that China is undergoing a dramatic economic slowdown. Could this set of circumstances represent an attractive investment opportunity? As far as stock market valuations are concerned, P/E ratios indicate that Chinese stocks, especially in the tech sector, have greater appeal at present. But does this reflect the reality?
There are many reasons for the fall in the Chinese equity market. The first is increasing regulation of Chinese tech companies aimed at restricting anti-competitive practices and governing the use of data. Another reason is the audit dispute between the US and China regarding Chinese companies listed in the US. On top of this, there is the regulation of the real estate market that harks back to the US economic crisis of 2008, the resurgence of the zero-COVID policy, and an uptick in fears linked to China’s geopolitical ambitions, particularly with regards to Taiwan.
Some prestigious investors have called time and fled the Chinese market, which they view as too risky at present despite offering strong long-term potential.
From a medium-term perspective, although the strict healthcare strategy in China is resulting in a domestic slowdown with international repercussions, we are now seeing a fall in COVID-19 cases, a slight easing of restrictions in some cities, and a resumption of intra- and inter-city movement. And although road, rail and maritime freight levels remain depressed, we seem to have passed the trough.
On the political front, at its last meeting at the end of April, the Politburo confirmed its desire to roll out accommodative monetary and fiscal policies to combat the economic slowdown. This is normally an excellent catalyst for risk assets, but the market seems hesitant.
One reason for this can be found in the geopolitical arena, namely in the accounting transparency of Chinese companies listed in the US. According to Bloomberg, progress is being made on this issue. If this is the case, it could help avoid the delisting of these companies from the US market and any related negative consequences.
The other reason, which is more nebulous, is Xi Jinping’s ambitions regarding Taiwan, which he considers China’s “23rd province” and has already threatened to invade. According to the Financial Times, an emergency meeting held on 22 April this year between Chinese regulators and national bank representatives covered measures to protect Chinese assets abroad in the event of US sanctions in response to an invasion.
For an investor, it may look like the right time to take on exposure, given China’s economic position, valuation, and fiscal and monetary policy. The geopolitical risk is harder to assess, given China’s commercial links with the rest of the world. After Putin’s invasion of Ukraine, any invasion of Taiwan by China would undoubtedly result in an unequivocal drop in Chinese assets.
Final version of 6 May 2022, by Benjamin Bourguignat, Fund Manager, LFDE