From ‘Uninvestable’ to Opportunity: Rethinking China’s Market

January 18, 2025
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From an equity perspective, this is exactly how many high-profile investment banks, fund managers, and commentators have described China in recent years. Citing lacklustre economic growth, an unresolved residential property crisis and its effects on consumer wealth and confidence, an underwhelming level of government intervention and support both for the economy and financial markets and, finally, deteriorating diplomatic relations between China and its trading partners, many investors have resigned themselves to ignore China as a destination worthy of serious consideration. For example, at a leading US investment bank conference in Hong Kong in February last year, 40% of those interviewed believed the country was uninvestable.

Were they right in 2024?

Well, as the chart below demonstrates, the answer is clearly no. Indeed, from the lows in February last year, the CSI 300, an index of leading companies listed on the Shenzhen and Shanghai exchanges, rose over 20% by the end of the year. However, all of the gains came in a brief period in September following a series of surprise government announcements designed to stimulate the equity market, the property sector, and the broader economy.

So, if the widely held view that China was uninvestable was wrong last year, is it still wrong?

To get a proper perspective on this question, investors need to try to quantify both the challenges still confronting the Chinese economy and the policy response and also look at the valuation of the wider market and some of its key constituent companies to fully appreciate whether those challenges are already priced in.

First, to get a broader perspective on the equity market's longer-term performance, I have included the chart below, which shows the CSI 300 index over the last 10 years. Clearly, although we have seen a significant rally from the lows in February last year, the market has been performing poorly for many years.

That is now reflected in a valuation that is very depressed, both in terms of recent history and compared with other international developing market valuations (see below). The fact that China has been trading below the average of its price-to-book ratio since 1996 is telling, as is the fact that it is lower than nearly all the other countries in this basket of developing economy markets.

Many of the bears on China would argue, however, that this low valuation is justified not just because of the many challenges confronting the economy but also because of the poor recent record of China’s corporate profitability. According to Financial Times data, 2024 will be the third year in a row when China’s corporate profits have declined. (See below)

Indeed, over a longer period, corporate earnings have lagged significantly behind real GDP growth, and return on equity has fallen from 15% to 11% over the last ten years. This, I think, reflects many factors in China, including frequent and unhelpful regulatory interventions, the low structural profitability of State-Owned Enterprises (SOEs), intense competition in domestic markets, endemic deflation, and a very weak consumption backdrop.

What happens next?

Importantly, the significance of the government’s stimulus measures is not just that they are targeted at sectors that need help (the equity and property markets) but that the government has recognised the need to take action to help rebalance the economy away from its traditional dependence on investment and exports and towards domestic consumption. This is not an easy task and will take time and more fiscal interventions, but critically, the leadership now recognises the need for action. Once Trump’s inauguration is past and there is more clarity on his tariff agenda, we will see more substantial fiscal measures announced that will specifically target stimulating consumer confidence and domestic consumption. These measures will take time to work, but my view is that the leadership has taken a decisive step in recognising the need to intervene.

Will they work?

The policy objectives to stimulate the equity market, stabilise the property market and nudge the household sector to save less and consume more are a challenging list, but China’s leadership has, at last, crossed a Rubicon in recognising the need for action and is taking concrete steps to achieve its desired outcome. If the initial measures prove insufficient, more stimulus will come later until the objective is achieved. In this sense, I believe it would be wrong to underestimate the leadership’s commitment to this cause.

Is China investable?

My view is yes, unequivocally. Having said that, I would not recommend a passive approach to this market opportunity. I think a more selective strategy is appropriate and probably necessary to achieve a good outcome in this market and this situation. Fortunately, there are many attractive options in the market that include, for example, most of China’s leading technology, social media, EV manufacturing and renewable energy businesses, which trade on a fraction of their US and other developed economy market peers’ valuations and yet are forecast to deliver good earnings growth in the medium term that compares well with what is forecast from those peers.

In summary, when an investor confronts a market opportunity characterised by a very low valuation, a supportive and improving macroeconomic backdrop, high-quality businesses delivering good earnings growth with strong balance sheets, and a highly sceptical investor community, that is always one that warrants close attention.

Disclaimer: These articles are provided for informational purposes only and should not be construed as financial advice, a recommendation, or an offer to buy or sell any securities or adopt any particular investment strategy. They are not intended to be a personal recommendation and are not based on your specific knowledge or circumstances. Readers should seek professional financial advice tailored to their individual situations before making any investment decisions. All investments involve risk, and past performance is not a reliable indicator of future results. The value of your investments and the income derived from them may go down as well as up, and you may not get back the money you invest.

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