It’s been a bit of a rollercoaster ride for Chinese equities in 2021. The market rallied in the first two months of the year, as Covid was well contained and we saw a return to economic growth, with strong inflows into the asset class, especially into Hong Kong. However, as the year progressed, several issues spooked the market: new regulation unnerved investors, leading to fears about a crackdown on the private sector more broadly; property developer Evergrande’s solvency issues raised questions about systemic risk; while a rise in Covid cases towards the end of the year led the government to reintroduce lockdowns and travel restrictions.
So, what does this mean for Chinese equities in 2022? We believe recent turbulence has been driven by panic, rather than changing fundamentals, and we continue to believe that the outlook for China is bright. Bouts of volatility are not unusual in emerging markets, so it’s important to look through the noise and negative headlines, and to focus on the bigger picture instead. Sharp, indiscriminate sell-offs like these can present attractive opportunities for longer-term investors.
Light at the end of the tunnel
In terms of regulation, we think it’s important to recognise that targeted regulatory changes are not uncommon in China – and past trends can show us what to expect from the latest regulatory action. As new regulations are announced, investors tend to panic as a lack of transparency means they expect the worst. In reality, policy announcements are often worded strongly to prompt an industry to conduct a self-review, but by the time they are finalised and as more detail is provided, they tend to be much more reasonable and less stringent than the initial announcements.
We think that we are nearing the end of the regulatory crackdown, and as more details emerge, we expect that investors will realise the latest regulations are not as severe as they originally feared. It’s also worth acknowledging that the latest regulatory cycle was expected as part of China’s latest five-year plan and its greater focus on ‘common prosperity’ – the welfare of households and equality, and more social responsibility by public and private enterprises, with the aim to ensure a sustainable, stable economic growth strategy. Given the private sector is one of the most important areas of growth in China, we think it’s unlikely the government would want to introduce policies to harm it.
On the macro front, we expect improvements next year too. This year, we saw some deleveraging (a debt reduction), with China’s debt-to-GDP ratio falling slightly, but next year, we expect to see more supportive monetary policy. We will likely see some loosening on the fiscal side too, where we anticipate new policy to encourage investment, as well as initiatives that aim to boost consumption.
Identifying the best opportunities
Over the longer term, our key investment themes have not changed: a focus on ‘consumption upgrade’, or growing demand for higher-quality, higher-price goods and services; innovation, as China strives to avoid the middle-income trap and upgrade its value chain; and healthcare, which is a long-term growth industry with strong fundamentals.
Following this year’s indiscriminate sell-off, stocks in the e-commerce sector are now looking very cheap, and we believe should perform well as greater clarity around regulation will allow companies to adapt to regulations and to grow. We expect to see strong earnings growth from e-commerce companies most likely in the second half of 2022. Elsewhere, we think the healthcare sector also looks oversold, as the regulatory crackdown spilled over into the sector due to rumours about price caps – but we believe the speculation is unfounded, and there are plenty of attractive investment opportunities in the sector. We also expect some short-term opportunities to arise in the property and education sectors, though we remain relatively cautious on these sectors until more details emerge.
An improving picture for 2022
We are optimistic about the outlook for Chinese equities in 2022, while as always, being mindful of the risks. We expect Covid-19 to be much less disruptive next year, though we acknowledge it’s difficult to predict, especially given its global reach. Elsewhere, we could see improvements in terms of easing US-China tariffs, particularly as we head into US midterms, where reductions would be supportive for US businesses and provide consumer relief against a backdrop of elevated inflation. 2022 also marks the 20th Party Congress in China, making it a significant year politically. According to past practice, authorities are likely to maintain policy stability to ensure a smooth transition; after having implemented significant reforms in 2021, we are likely to see strong GDP growth and greater stability in 2022.
Right now, we believe that the risks are more than priced in in many areas of the market. China is currently one of the cheapest equity markets globally (on a relative valuation perspective), and we view recent market weakness as a great buying opportunity.
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