Key takeaways
 
  • The MSCI China index dropped 30% between 1st September and 31st October, one of the sharpest drawdowns we’ve seen in recent history.
  • Continued lockdowns have severely dented consumer confidence and impacted supply chains. However, a month on, we have seen several waves of positive news flow in China.
  • Looking ahead to 2023, the path to covid reopening in China is likely to be bumpy but we will continue to do what we are best at, which is bottom-up stock picking and generating alpha for our clients in what has been a volatile market environment.

It won’t have escaped you that Chinese equity markets have been more volatile than usual. The MSCI China index dropped 30% between 1st September and 31st October, one of the sharpest drawdowns we’ve seen in recent history. 

Figure 1: MSCI China Index

Source: Bloomberg. Data at 1st December 2022. (Price only, HK$)

The main culprit was uncertainty stemming from China’s Zero Covid Policy. Announcements from China’s health officials were failing to provide any clear roadmap for how Covid policy would evolve. Vaccination of the elderly essentially stopped in July, with the proportion of over 60s having received a booster shot stuck at around 66%. This shortfall was preventing any orderly reopening, with the fear that the covid death rate could shoot up rapidly due to limited numbers of ICU beds and other medical facilities needed to handle a large influx of covid patients.

Why hadn’t the authorities done more to ensure vaccination amongst the elderly? We were left scratching our heads, could it possibly have been that they had no plan to re-open in the foreseeable future? Continued lockdowns have severely dented consumer confidence and impacted supply chains. Most companies in their quarterly reports referenced lockdown-related disruption and consumer downtrading.

The market moved into panic mode when the Standing Committee was filled with Xi loyalists at the Party Congress. Investors were worried that: China would abandon its growth target; there would be no push back against Xi’s Zero Covid Policy; property sector tightening would continue; and lingering US-China geopolitical tensions would encourage more US based pension funds to divest from Chinese markets. Our approach is normally to avoid panic and take a long-term view, but what exactly was our confidence based on?

  • A huge amount of pessimism had already been priced into the market, with the MSCI China index trading at 8x Price-to-Earnings and 0.9x Price-to-Book, the lowest levels reached in a decade. Full year earnings per share (EPS) expectations had also been cut aggressively from HK$8 at beginning of the year to HK$5.5 by October.
  • In our assessment, Xi’s re-election and strengthened leadership position meant a likely continuation of policies implemented over the past decade, rather than a sudden pivot towards anti-growth policies.
  • Although there was no visibility on a timetable for covid reopening, macroeconomic challenges and high youth unemployment were likely to see pressure build on the government to lift covid restrictions. Public opinion would also become comfortable with the idea of eventually shifting towards living with covid, as the rest of the world has.
  • Last but not least, our portfolios’ Chinese holdings reflect our strong preference for fundamentally sound companies with strong balance sheets and excellent free cash flow generation. We remain confident that they can withstand the challenge of time, and emerge from the pandemic stronger, gaining market share from weaker competitors.

As contrarian investors, we tend to be greedy when the market is fearful. We took advantage of recent volatility to top up exposure to reopening plays in China, including a restaurant chain operator, a cosmetics company, a casino operator and selected internet companies.

One month on, we have seen several waves of positive news flow in China. On covid, the authorities have started to loosen quarantine restrictions, with local government appearing set to be given vaccination targets. For the property sector, state-owned banks pledged to provide over renminbi (RMB) 1trn credit to support high quality developers, while the People’s Bank of China is going to provide RMB 200bn new loan quotas to complete stalled residential projects. At the G20 summit in Bali, Xi and Biden’s first face-to-face meeting since the latter's election has brought hope that the deteriorating relationship between the two countries has found a floor. The MSCI China index has rebounded strongly from its recent low, with gains of nearly 30% in November.

Looking ahead to 2023, the path to covid reopening in China is likely to be bumpy, with three steps forward and then two back. However, the direction of travel is clear: China will have to learn to live with covid and is finally laying the ground to minimize the health impacts of doing so. We will continue to do what we are best at, which is bottom-up stock picking and generating alpha for our clients in what has been a volatile market environment.

Want to find out more?

View the RSMR Factsheet here: Invesco Asia Trust plc | Invesco UK

 

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