Portfolio Chart: A menu of options as bond yields reset higher
With yields hovering close to decade highs across many fixed income sectors, investors are presented with a “menu of options”. Still, selectivity matters as recession risks loom.
As China’s economy reopens, undemanding valuations and a growth-friendly policy path could present equity opportunities1.
Active management is crucial when seeking out long-term, secular growth opportunities in China’s markets. We believe technology, consumer and renewables are key themes as China lives with COVID-191.
And just like that …
… China has begun to reopen, capping more than three years of COVID-19 isolation.
This landmark shift could present some positive tailwinds after a year that saw asset prices swooning in the face of aggressive monetary policy tightening and slowdown in economic activity.
A fresh catalyst for China equities
Following a period of adjustment towards living with COVID-19, China’s domestic economic activity could accelerate, owing to meaningful pent-up demand and excess savings to the tune of trillions of RMB in deposit accounts2. Unlocking these resources could potentially support the outlook for domestic consumption, corporate earnings and profitability2.
Currently, valuations of China equities look relatively undemanding, as illustrated below. This, coupled with the shift to a growth-friendly policy stance and subsequent economic recovery, may have meaningful implications to the outlook of China’s equity markets.
Valuations look undemanding and China’s economic reopening could present a fresh catalyst for recovery
Capturing long term growth opportunities in China
Tapping enduring investment opportunities in China requires robust fundamental research and rigorous bottom-up stock selection. Being on-the-ground is crucial to truly understanding the business and dynamics of China’s equity markets which, while broad and liquid, remains inefficient with a high level of pricing anomalies. Ultimately, active management is key to navigate a year of major policy shifts and macro changes in China’s economy.
Diversification from the US & Europe
Chinese equities can bring potential diversification benefits for portfolios as well. For one, investors globally remain underinvested in the onshore Chinese equity markets relative to the size and importance of the Chinese economy.
Historically, China’s onshore equity markets have exhibited low correlation with developed markets given China’s relatively distinct economic and policy cycles. For example, while developed market central banks remain mired in a tightening posture due to persistently high inflation, relatively elevated policy rates and manageable inflation in China suggest meaningful room for further policy stimulus. As a result, onshore Chinese equities may present potential diversification opportunities against the looming downturn in the US and Europe4.
Furthermore, in line with China’s decreasing dependence on the US and Europe as key export markets, the bulk of revenue exposure for the MSCI China Index is domestically driven, which suggests less vulnerability to the economic headwinds facing the developed world, as illustrated below.
Domestically driven, Chinese equities can offer diversification from the US and Europe
Key secular themes present opportunities
The economic reopening could provide a cyclical boost to long-term structural growth opportunities in China, spanning technology, consumption and carbon neutrality1. Companies with lean cost structures and strong pricing power are well-suited to ride the reopening trend, in our view.
China’s reopening rebound is likely to be driven by consumption rather than investment4. This recovery will likely be centred on consumer-sensitive sectors such as tourism and retail markets. Growing affluence and an expanding middle class will continue to support the ‘premiumisation’ trend while industry consolidation in some areas can help compound growth.
Robust healthcare spending and investments will continue to drive opportunities in areas such as medical equipment and structural outsourcing, including both contract research organisations (CROs) and contract manufacturing organisations (CMOs).
Software companies continue to ride the digitalisation trend, aided in part by the government’s support for the creation of domestic champions.
Automation and other productivity enablers in the industrial and technology sectors are also key beneficiaries in the drive to boost growth through productivity improvements, in the face of a ‘greying’ workforce and rising wages. The continued focus on import substitution, self-sufficiency and national security will also help to buoy the growth of strategic sectors such as semiconductors.
3. Carbon neutrality
Sectors supporting the development of a “Green Economy” such as electric vehicles (EV), solar and advanced manufacturing are likely to play a key role in generating sustainable growth over time3.
Rising EV penetration, stricter emission controls and standards, and faster adoption of renewable energy could continue to support revenue and earnings growth of related segments. Additionally, the EV supply chain and renewables such as solar power supply chains, installation, and storage present other interesting opportunities. This is particularly important considering that China continues to take global market share in solar production.