23 Oct 2024
James Syme, Senior Fund Manager | Ada Chan, Senior Fund Manager | Paul Wimborne, Senior Fund Manager
There has been a lot of focus in recent weeks on the signals being sent by bond markets regarding the outlook for growth. This has very much included some emerging markets, such as Brazil and Mexico, but we believe that it has tended to overlook some dramatic moves in Chinese bonds.
Since the start of the year, the US five-year bond yield has fallen slightly. Medium-term bond yields in many emerging markets have in fact risen amid concerns that a strong US dollar would delay interest rate cuts, or even -as in the case of Indonesia – lead to interest rate hikes. In China, though, the five-year bond yield has fallen from 2.4% to less than 1.9% (as at end August 2024).
This has led the Chinese central bank, the People’s Bank of China (PBoC), to worry about a bubble in Chinese government bond prices, and PBoC has been gently intervening in markets to try to prevent bond yields falling too far or too fast.
For all PBoC’s concerns, these moves in yields look rational to us. Inflation in China is low and quite possibly negative: the latest inflation measures are +0.6% for CPI, -1.8% for PPI (to August 2024) and -0.7% for the GDP deflator (for Q2 2024). Deflation increases the real yield on bonds, while both real estate and equities are potentially hurt by deflation in a leveraged economy.
As well as the signal from inflation, the credit environment is also indicating an ongoing deflationary slowdown in the economy. The July lending data showed a contraction in bank loans, with both corporates and households looking to pay down debt. It is the first contraction in lending in the economy since 2005, despite the period since including the GFC and Covid.
Given the historical pattern of a decade-long, debt-driven real estate boom followed by what looks like a debt-deflationary slowdown, there is a temptation to see China as falling into the same kind of balance sheet recession that Japan experienced after the boom finished in the late 1980s. As this year has also seen the Nikkei equity index finally exceed its 1989 peak, do Chinese equities also face a similar ‘lost decade’ to Japan in the 1990s?
One group who might worry that it does are the Western multinational companies who have been reporting sharp downturns in their China sales in recent quarters. From beer to luxury products to cosmetics to cars, a clear pattern has emerged of results commentaries warning about Chinese demand.
However, we feel that a more detailed look at company results shows a different, more promising pattern. In these same consumer segments, as well as in areas like travel and tourism and e-commerce, many Chinese domestic companies are reporting good results and earnings growth, while consensus estimates of future earnings are being revised up. We feel this reflects both Chinese consumers pivoting to different products and lower price points, and also to a new preference for domestic Chinese brands. For example, the market share in car sales held by foreign brands has fallen from 64% to 38% in the last four years (4 years to August 2024). A similar pattern is emerging in other products, including beer and cosmetics.
With these companies performing well, the broad equity market weakness in China of the last four years (especially for Hong Kong-listed names) has pushed some of these companies to attractive valuations, especially when compared to falling bond yields.
The Chinese economy is struggling for growth; the credit environment is particularly difficult; there has so far been no turnaround in the wider real estate market. But our view is that does not mean there is no opportunity in Chinese equities. We remain overweight Chinese equities in the portfolio with exposure to a highly selective set of stocks.
Professional investors only. This is a marketing communication. Please refer to the fund prospectus and to the KIID / KID before making any final investment decisions. The investment promoted concerns the acquisition of shares in a fund and not the underlying assets. Past performance is no guarantee of future performance. The value of an investment and the income from it can fall as well as rise as a result of market and currency fluctuations and you may not get back the amount originally invested. The information contained herein including any expression of opinion is for information purposes only and is given on the understanding that it is not a recommendation. The information in this article does not constitute, or form part of, any offer to sell or issue, or any solicitation of an offer to purchase or subscribe for any funds or strategies described in this article; nor shall this article, or any part of it, or the fact of its distribution form the basis of, or be relied on, in connection with any contract.
Source: JOHCM (unless otherwise stated.)