Thinking about Chinese stocks? Read this country-level analysis first

Our Emerging Markets team always starts with a top-down, country-level investing framework. Here’s how their framework applies to China right now.

This is a monthly insight from James Syme, Paul Wimborne and Ada Chan, co-managers of Pendal’s Global Emerging Markets Opportunities Fund

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CHINA has undergone major political change recently with the consolidation of Xi Jinping’s power in his third term as leader.

Chinese equities have also aggressively de-rated in valuation terms this year.

As emerging markets investors, how has our view on China changed?

Our investment process is designed to be alert not just to market drivers — but also to changes and trends, surprises (positive and negative) and forecasts and surveys.

The philosophy behind that process emphasises a disciplined and repeatable country analytical process.

When reviewing recent develoment in China, we stick to our core five-point framework in reviewing the outlook for Chinese equities in USD terms over the next two years.

Here’s what that tells us.

What the data says

Growth in China is weak by historic standards. Strong exports are offset by very weak domestic investment and consumption.

Third-quarter GDP was up 3% year-on-year, with industrial production up 6.3% and exports up 10.7%.

But retail sales were up only 2.5% and property sales (for the 31 main listed players) were down 29% (all to September).

The crippling effect of China’s “Three Red Lines” restrictions on lending to property developers continues to have a devastating effect on the sector. Meanwhile ongoing Covid lockdowns hurt confidence-hit consumers.

The outlook does not seem to be improving either. October PMI surveys weakened to 48.7 for non-manufacturing and 49.2 for manufacturing.

Can fiscal policy drive growth?

This December’s Central Economic Work Conference can shift the emphasis of fiscal policy while keeping to agreed policy parameters.

Probably the most effective change would be to directly support for households, given the downturn in domestic consumption.

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Targeted fiscal measures to support consumption have been successfully used in previous downturns — for example subsidies for rural purchasers of home appliance in 2008, or support for car-buyers in 2014-15.

But given the weight of real estate and adjacent sectors in the economy, this is unlikely to do more than help specific industries.

The liquidity and credit environment will need to do some of the lifting. But the ability to enact monetary stimulus is constrained by weak private credit demand and concerns about the exchange rate.

The capacity certainly exists. Despite global inflationary pressures the Chinese economy is heading into deflation.

PPI inflation trackers dropped into negative territory in October (after a September print of just +0.9%). Household and corporate excess deposits continue to collect in the commercial banking system.

This is likely to eventually lead to increases in credit quotas and cuts in interest rates.

But these are unlikely to work for two reasons.

Dual challenges

Firstly, private sector credit demand is extremely weak. Simply making it cheaper and more available is unlikely to change that.

This is a classic crisis of confidence, in which the central bank can end up “pushing on a string”. Either policies change to create confidence, or fiscal policy must do the work.

Secondly, while the Three Red Lines restrictions on private sector property developers are still in place, the key sector that isn’t borrowing will remain unable to do so.

In fact, credit conditions continue to worsen for private sector developers. Bond yields are climbing steadily for even the highest-quality issuers, suggesting the situation will get worse before it gets better.

The currency was at its all-time real effective exchange rate in the first quarter of 2022.

Although it is notionally supported by net exports — and protected by capital controls — it is likely to weaken relative to the US dollar.

This is partly because of interest rate differentials, and partly because policy makers in East Asian exporters must keep their currencies reasonably in-line with the depreciating Japanese yen.

The Xi factor

Management and politics are the key, despite the previous three drivers.

President Xi Jinping has been appointed for an unprecedented third term. An overhaul of the Politburo Standing Committee saw market-friendly reformers (including Premier Li Keqiang) removed and replaced with members seen as Xi loyalists.

State media have begun referring to Xi Jinping as ‘Core’ leader while establishing his political views (Xi Jinping Thought) as doctrine.

This marks a move away from the ‘Collective Leadership’ system of Chinese politics that has been in place since the 11th Party Congress in 1978.

An economic focus on technology and quality of life adopted at the 2017 Congress remains in place.

The main changes at this Congress were on governance and national security, with emphases on international relations, geopolitics and reunification with Taiwan.

About Pendal Global Emerging Markets Opportunities Fund

James Syme, Paul Wimborne and Ada Chan are co-managers of Pendal’s Global Emerging Markets Opportunities Fund.

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
 
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