Missed the China rally? Think again, we still see value and the rest of Asia and EM might be next (2024)

Key takeaways

1

We see value in China, despite the rally and the earnings outlook for companies has fundamentally improved

2

Pro-growth policies, intra-Asian trade, and tourism should support domestic demand in the rest of Asia

3

Opportunities are now emerging in Latin America where we have been adding to our strategies

No one will have missed China’s re-opening story. The MSCI China index is up around 50% since its trough on 31 October 2022. As it turns out, China is not Russia and investors were wrong to panic. The drip of positive news coming out of China is a sea change from 3-6 months ago, as discussed in a well-timed blog by fund manager Fiona Yang: China reopening update.

China moved from a zero-Covid strategy to one of herd immunity in December 2022. Measures have been put in place to improve the economy. A 16-point plan to support the property sector was announced in November 2022. These included an easing of funding constraints to cash-strapped private developers and mortgage rate cuts. Strict antitrust, privacy and taxation regulations surrounding Chinese internet companies have now started to ease.

China is also ready to repair its frayed ties with Australia. After a series of defence, trade and foreign policy disputes, the relationship between the two countries went into freefall in 2020, with Beijing imposing a range of punitive trade actions on Australian exports from coal to barley, lobsters and wine.

We have consistently gained value from our Hong Kong/China exposure in both our Asia and Emerging Market strategies from the February 2021 peak and through the downturn. We did so by avoiding what we believed to be ‘frothy’ areas, where stock prices had risen to exorbitant levels that were no longer justified by fundamentals. We have benefitted from the recent bounce from the trough by owning a good mix of underappreciated names whether ‘growth’ or ‘value’.

Our Asian and Emerging market strategies are underweight India, the market we believe to be the most expensive. Given the Indian market’s recent poor performance,1 this has served us well. Meanwhile, Indonesian stock markets bore the brunt of the renewed interest towards China. Given that we’ve always believed that investment opportunities can be found in unloved areas of the market, our fund managers Ian Hargreaves and Fiona Yang have timed their visit to Indonesia well.

Chinese equities: Invest before the market trend begins

We are contrarian investors. One of the strengths of contrarian investing is a deep-rooted awareness of under-priced value. The challenge is to capture it before others do.

Finding value in China was not predicated on what has been dubbed “the mother of U-turns,” which caught everyone by surprise, including our Asia and Emerging Markets team. The real question was whether the zero-Covid policy was tenable over a 3-5-year investment horizon. We thought not.We argued that expectations embedded in valuations were too low for many Chinese companies as the overall market edged towards book value.

Understanding the opportunity in Chinese equities

Weincreased our active exposure to China by around 12% over the course of 18 months in our strategy, going from a significant underweight to a slight overweight.Indeed, our approach is to lean into risk because markets don’t tend to reward investors for certainty and what feels comfortable.

In that sense, a contrarian approach is not about predicting the future, it’s about capitalising on excessive negativity. This approach can be especially rewarding at inflection points like these.

What’s next for the Chinese markets?

Despite the sharp rally, we still see value in China. The market is essentially back to where it was mid-2022. The earnings outlook for companies in China has fundamentally improved and there is plenty of scope for positive surprises which can validate a re-rating towardshistorical average levels. The market is still 45% away from the historical average price-to-book (P/B) of 1.9x.

There’s pent-up demand for goods and services. Chinese households have accumulated a lot of savings, estimated at 30% of disposable income compared to the typical 10-15%. If 2019 demand was a roughly “normal” year then demand in say second half of 2023 may be super-normal, which could see some positive surprises. This bodes well for the consumer sector, which accounts for a significant portion of our China exposure.

We are beginning to see the effects of a more benign regulatory environment for large internet companies – andare selectively overweight leading e-commerce and online media platforms.

While some exuberance over the shift in policy is palpable, the reality on the ground is still very challenging.As one client put it "we're looking for evidence of a recoverybefore committingmoney". With investors still digesting the swift turn of events in China but also concernedabout a US recession, markets may be choppy andoffer good entry points at the stock level over the course of 2023. The rest of Asia can benefit indirectly from China’s reopening as the centre of gravity in the region.

Will the rest of Asia and emerging markets also rebound?

It’s difficult to overstate China’s influence on the region and the wider emerging markets. Around 60% of China’s trade is intra-Asia and China’s pull-on commodities demand remains strongat the margin without relying on a resumption of debt-fuelled capital spending, which is unlikely.

Chinese tourists represented 20% of international tourism spending according to pre-pandemic estimates. According to data from Ctrip - the Chinese travel platform - travel bookings by Chinese tourists over the last couple of weeks for Southeast Asia has increased 10-fold compared to a year ago, particularly for Thailand, Singapore and Indonesia. The Tourism Authority of Thailand are expecting 300,000 Chinese tourists in the first quarter alone. Other major Asian destinations include Macau, Hong Kong, Taiwan and Australia. This is encouraging at a time when advanced economies are slowing.

China’s closest trading partners such as Korea and Taiwan are set to benefit, and valuations there have become attractive thanks to the imminent troughing of the semiconductor cycle – the point at which the upside risk is greatest – so we have been adding.

Thepick-up in pro-growth policies, intra-Asian trade, and tourism should also support domestic demand in the rest of Asia – we are overweight financials, especially insurance companies, and auto-related businesses in Korea and Indonesia.

Many non-Asia emerging markets such as Brazil and other oil producing nations have lagged the recent rally, reversing some of their earlier strong performance. The change of leadership has added nearly 5% alpha to our EM strategy outperformance, but opportunities are now emerging in Latin American where we have been adding to our strategies.

The Asia and EM underperformance is long in the tooth. Over a decade. Although this was justifiably driven by lower earnings growth compared to US equities when denominated in US-dollars, this may change. US-dollar strength is being challenged by an imminent recession in the US to root out inflation.

While inflation in the US may be stickier than expected it is declining, which may lead to an easing of financial conditions at a time when Asia is recovering. Inflation is less of an issue in Asia which provides some policy flexibility. Finally, the China reopening puts a floor on the economic and earnings growth downgrades seen in 2022 – a narrowing of the valuation discount is on the cards.

Our strategies have benefited from the China rebound but it’s not the only game in town - the rest of Asia and EM have scope to benefit and surprise positively.

FAQs

This index has around 717 constituents and covers about 85% of the Chinese equity universe. It represents the performance of large and mid-cap segments across China A shares, B shares, red chips, P chips and foreign listings in China stocks. It is considered the de facto index for all of China.

China accounted for 18.6% of global GDP in 2022, according to Statista. This is expected to rise to 19.9% by 2027. Around 40% of China’s GDP is made up of construction and industry sectors. These include mining and ore processing, food processing, coal, machinery, textiles and apparel and consumer products.

China is the largest economy in Asia. This is followed by Japan, India, South Korea and Indonesia.

For those with a long-term investment horizon, the case for investing in Asia is as strong as ever. Favourable structural trends are driving growth in the region, creating plenty of investment opportunities – and not just within China. However, investors need to be aware that there are big valuation discrepancies between and within markets and sectors. Adopting a rigorous approach to investing will remain key to investment success.

Asia is the world’s growth engine. Demographic shifts and digitalisation will only serve to reinforce this view. With a growing middle class and increased connectivity, the region is now home to a vast pool of digital consumers, who are keen to adopt new products and technologies. Asian companies willing to innovate to meet the rising needs of domestic consumers are thriving in this environment.

Missed the China rally? Think again, we still see value and the rest of Asia and EM might be next (2024)

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