The Return of China

  • China’s stock market has had a tough 3 years with the Morningstar China Index down 42% between the end of January 2021 and the end of March 2024
  • China is at its lowest valuation in nearly a decade, more than a 50% discount to the US
  • Corporate earnings in China have been improving and consensus estimates are for 15% EPS Growth in 2024.

The past few years

China has faced some significant headwinds for over half a decade that have really weighed on the country’s economic growth and made the market almost uninvestable in recent years. In 2018 and 2019 economic growth started to slow with the infamous trade war with the United States leading to a slowdown in manufacturing and exports. The Covid-19 pandemic then hit and China’s growth slowed further to just 2.3%, however, this did mean that it was the only major economy to actually register positive growth in 2020.

2021 was a standout year for China’s economy as they rebounded strongly out of the pandemic posting an accelerated growth rate of 8.1%. This was helped largely by the enormous amount of investment from the Chinese government into infrastructure and technology as well as into real estate from property developers. Exports also surged as the world reopened – Biden kept the tariffs from the trade war in place but didn’t escalate it further. This didn’t translate into stock market performance, however, as there were concerns around the sustainability of this growth and rising debt levels.

These concerns were validated in 2022. Stringent lockdown measures under China’s zero-covid policy caused massive economic disruption and consumer spending to dry up. China is a global hub for manufacturing and as factories closed, supply chains were disrupted, severely impacting export activities. On the Real Estate front, we saw Evergrande, one of China’s largest property developers, fail to meet its debt obligations which highlighted serious issues within the sector – construction projects began to shut down around the country and property prices plummeted. At the same time, rising inflation, regulatory crackdowns and power outages squeezed profit margins.

After a brutal couple of years, investors hoped that 2023 would see the recovery of the world’s second largest economy but this failed to materialise as the CSI 300 (top 300 stocks on the Shanghai and Shenzhen Stock Exchanges) slid 13% whilst the S&P 500 soared 22%. The Morningstar China Index is now down 42% from the end of January 2021 to the end of March 2024 as shown by the below chart:

Source: Morningstar, “Time to Look at Chinese Stocks Again?”, 24 April 2024

The Upside

We want to illustrate the upside in a series of four charts:

Source: JPM Guide to the Markets, 13 June 2024

Despite strong GDP and EPS Growth forecasts, China is trading at a valuation not seen in nearly a decade, well below its 35 year average and below all the other major regions. It is at more than a 50% discount to the US and Morningstar estimate a 31% discount to fair value. You can’t just buy something because it’s cheap though otherwise you leave yourself exposed to ‘value traps’. China’s GDP grew by 5.3% YoY in Q1 2024, ahead of expectations and the first sign that it may be turning a corner.

Bowmore Portfolios

In our Core Risk 5 portfolio, we have just 2.6% of Equity exposure in China. With corporate earnings steadily improving, a rerating is certainly on the cards but it is a high risk play. The real estate debt crisis is ongoing plus there is a lot of geopolitical tension with Taiwan and potentially Trump. Consumer confidence remains subdued and we just need to see a little bit more positive data surrounding consumer spending and inflation (or rather deflation in China’s case) before increasing our exposure.

 

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