How Emerging Markets investors should approach China now

BEIJING’S public insistence on zero Covid tolerance has put a question mark over China’s economic outlook — and raised concerns its growth targets are too ambitious. JAMES SYME explains what it means for investors

• Covid lockdowns threaten outlook
• PMI data weakest since height of pandemic
• Wait for policy response: James Syme

CHINA’s economy grew at a better-than-expected 4.8% annual rate in the first quarter, despite pandemic lockdowns in major cities and the repercussions of a tightening of regulations on property developers.

But Pendal’s James Syme says a more telling figure may be the recent Purchasing Managers Index — a monthly survey of business activity — which showed activity falling to its lowest levels since the height of the pandemic.

“We can only focus on the data and the PMI is a powerful guide to how problematic things are in China,” says Syme, who co-manages Pendal Global Emerging Markets Opportunities Fund.

“The PMI was quite soft in the manufacturing sector and extremely weak in services.

“And remember these are national figures — if the national figure is at these levels than some parts of the country must be really weak.”

Syme says the problems for China’s outlook stem in a large part from the last year’s tightening of regulation in the real estate sector as Beijing enforced its ‘three red lines’ policy limiting developers leverage in proportion to their equity, assets and cash.

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“China essentially delivered a huge negative shock to the economy,” says Syme.

“There’s lots of focus on other regulations in education and technology because those have more of the stock market impact, but those sectors are not particularly big in terms of the overall economy.

“It was the enforcement of the three red lines policy in real estate which had a really serious chilling effect on what is one of the was probably the largest sector in China.”

Syme says the effect was wider than property prices, impacting demand for building materials, construction equipment, white goods and furniture.

Now, Covid-related lockdowns and port closures in major cities are posing further threat to the economic outlook.

“This might be short term, as it was in February 2020,” says Syme. “And clearly with vaccinations, China is in a better place than it was before.

“But the outlook for the Chinese economy is really quite uncertain at this time.”

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Market nerves about the outlook mean some of China’s most high profile and fastest growing companies are trading at lower prices than they have for years.

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“Our policy has always been that cheapness alone is not a driver — you need signs of positive economic or political direction,” says Syme.

Syme says the most important thing is to wait to see Beijing’s policy response to the slowdown.

To date, Beijing has not intervened with a loosening of monetary policy or fiscal stimulus and appears to be seeking to export the nation’s way back to growth.

“But that’s probably not going to be enough in itself,” says Syme.

“We’ve seen the Chinese trade balance just continue to grow and if you think of a country’s trade balance as what it produces minus what it consumes, a stronger trade balance is really just more evidence of economic weakness.

“At some point, there’s going to have to be some kind of stimulus — but then we go back to the problem that Chinese policymakers have that they want to constrain debt to GDP.

“But if you want to use stimulus you have to grow debt faster than GDP.”

And longer term?

“There’s only so long that China can grow much faster than the rest of the world,” says Syme.

“Those six and half percent growth rates simply couldn’t be maintained forever.”

About James Syme and Pendal Global Emerging Markets Opportunities Fund

James Syme is a senior portfolio manager of Pendal’s Global Emerging Markets Opportunities Fund with Paul Wimborne.

The fund aims to add value through a combination of country allocation and individual stock selection.

The country allocation process is based on analysis of a country’s economic growth, monetary policy, market liquidity, currency, governance/politics and equity market valuation.

The stock selection process focuses on buying quality growth stocks at attractive valuations.

Find out more about Pendal Global Emerging Markets Opportunities Fund here
 
Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.

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