14 Mar 2025
China's economic landscape presents a mix of challenges and opportunities for investors. While tariffs and regulatory concerns have impacted sentiment, the focus on domestic revenue-generating companies and supportive government policies offer a cautiously optimistic outlook. Fidelity China Special Situations PLC portfolio manager Dale Nicholls shares his latest thoughts on the investment outlook for China and how the trust is positioned to navigate the current environment.
Key points
Tariffs are front of mind for investors looking at China. In terms of impact, if you take the MSCI China for example, the percentage of ultimate revenue exposure for companies, is in the low single digits. Generally, companies are more prepared for potential tariffs and these have also been priced in for companies.
Moreover, the majority of firms in the benchmark and portfolio are domestically focused and this will likely mitigate the adverse impacts of international trade disputes.
Chinese companies themselves have been well aware of the risks related to tariffs, and many have diversified supply chains, leveraged tariff exclusions, and adapted by manufacturing in alternative locations to mitigate their impact. In fact, we are finding opportunities from more cases where the market may be underestimating the resilience of Chinese companies in the face of these challenges.
Property sector stabilising
We see an end to the property slump as key in turning around the economy and perceptions more generally about China and its share market.
Going forward, we think the property sector is likely to be less of a drag on GDP. That’s not to say the risk is no longer present but there have been positive changes to build on. The risks are well understood within government, and there seems to be a clear focus and directive from the top. With conspiring forces at play the sector has a good chance of stabilisation from here.
The consumer has been underspending, with strong savings built up and lower household debt. The issue is one of confidence. After so many years of property being the cornerstone of consumers’ portfolios, it was natural that it might take some time for confidence to be restored after the collapse of the property sector.
Regulatory environment softening
Chinese consumers are concerned about employment security - having seen the regulatory crackdown on (tech) companies which forced them into cutting costs and jobs in some organisations. However, in our current conversations with the tech companies, management are sounding much more positive, and we anticipate that most of the job cuts are behind us now. Companies are looking to grow, and we see them reinvesting profits, in areas such as R&D.
The level of innovation that we are seeing on the ground in China continues unabated. Earlier this year we saw DeepSeek, a small Chinese startup based in the eastern tech hub of Hangzhou, stun the world by introducing a low-cost AI model that nearly matched the performance of its more expensive American rivals.
There have been increases in China’s R&D, and the highest level of patent filings in the world at nearly 50% of all global filings.1 Take the Electric Vehicle (EV) sector for example, where China is dominating the market, having high penetration in their domestic market which has helped power them to a position of global leader. Chinese companies are also taking massive market share not just in vehicles but the whole supply chain.
Regulatory issues, which were a cause for concern in the past, are now seen as less daunting, with the government's focus shifting towards fostering growth.
Government stimulus signals a great focus from the top on addressing risks such as deflation and lower growth, they have shown commitment which is encouraging. We think there will be likely be more policy announcements later this year, and some further targeted measures on the property sector.
Valuations look attractive versus history
The aggregate earnings growth outlook for corporates exposed to China’s new growth remains promising and has not yet been reflected in market returns. There remains room for Chinese equities to re-rate higher and while markets may see increased volatility, we should remember fundamentals will always be the key driver of longer-term returns. Valuations in key sectors are trading at multi-year lows and with the MSCI China Index trading at a steep discount to US equities, offering compelling opportunities.
Looking across the domestic market we see opportunities in companies in the tech sector, within the trust we’ve looked to increase positions in consumer discretionary and consumer staples over the last 12 months.
The industrials sector is another significant focus area, driven by China's ongoing infrastructure development and modernisation efforts. This sector is expected to benefit from government policies aimed at boosting industrial growth and enhancing productivity.
Healthcare, on the other hand, has underperformed, presenting a potential opportunity for offering value. The financial sector, particularly insurance, also holds significant promise. The Chinese insurance market is less developed compared to Western markets, indicating substantial growth potential. Companies in this sector are well-positioned to capitalise on the increasing demand for insurance products, driven by rising income levels and greater awareness of financial planning.
Portfolio holdings
One of the holdings within the Trust is ByteDance, the owner of TikTok, where we have increased our position. While there is a lot of focus on the US, the US market only represents around 10% of TikTok users globally, so we believe there is ample opportunity for the business elsewhere. In terms of valuation, its rest-of-the-world reach feels underappreciated.
Consumer sectors were among the worst performing last year, but valuations now offer some of the most compelling opportunities. In e-commerce, the largest platforms continue to leverage natural network effects, their strong market position and improved cost control to improve earnings growth. PDD remains among my preferred holdings, with valuations not reflecting continued strong trends domestically as well the potential for TEMU overseas.
Another example is Tuhu Car, China's leading auto tire and maintenance service provider, leveraging digitalisation to transform customer experience, standardise services, and drive efficiency. In a fragmented market dominated by small local players, Tuhu created a highly scalable, capital-light model and has consolidated its position as the largest player, with over 4,000 franchised stores. Structural tailwinds such as China's aging car fleet fuels demand for maintenance, and Tuhu's large scale in tire purchasing, enables it significant pricing power. The company also has substantial margin expansion potential through private label products, offline traffic growth, and enhanced chassis services. With a proven growth strategy and few direct competitors, we believe Tuhu remains an attractive long-term investment.
Lastly, there is Full Truck Alliance, a leading China platform to match long-haul freight transportation between truckers and shippers, replacing offline truck matching brokers at lower logistics cost and higher efficiency. Thanks to its established dominance in the space and network effect, the company enjoys strong counter-cyclical growth through digitalization on increasing cost-sensitiveness and faces little competition as the sector has thoroughly consolidated.
1Source: WIPO Statistics database, December 2024. China represents Mainland China excluding Hong Kong SAR.
Important information
This information is for investment professionals only and should not be relied upon by private investors. Investors should note that the views expressed may no longer be current and may have already been acted upon. Changes in currency exchange rates may affect the value of investments in overseas markets. Investments in emerging markets can be more volatile than other more developed markets. Investments in smaller companies can carry a higher risk because their share prices may be more volatile than those of larger companies. Fidelity China Special Situations PLC can use financial derivative instruments for investment purposes, which may expose it to a higher degree of risk and can cause investments to experience larger than average price fluctuations. Its shares are listed on the London Stock Exchange and their price is affected by supply and demand. The investment trust can also gain additional exposure to the market, known as gearing, potentially increasing volatility. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only.