China Currents

Look below the surface: A contrarian view on China equities

Ben Chen, Equity Research Analyst
2024-05-31
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The views expressed are those of the author at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.

The landscape of China's current economic situation is akin to scuba diving beneath turbulent waters. At first glance, the surface waves appear chaotic and perplexing, much like the headlines that often dominate discussions about Chinese equities. In my view, if you look below the surface, you can discover a market that is deep, diverse, and teeming with hidden gems.

As contrarian investors, our goal is to identify high-quality companies that are currently facing temporary challenges. We believe that companies possessing this character have the potential to deliver meaningful returns but are frequently undervalued due to the market's fixation on short-term factors. Our conviction lies in the belief that the most promising investment opportunities often lie in areas that most investors have either overlooked or have prematurely dismissed. In the present climate, we find a myriad of such opportunities in China.

Despite the abundance of internal and external challenges confronting China, there are still several positive aspects that deserve consideration:

First, we believe the ongoing restructuring of the real estate sector is poised to yield favorable outcomes in the medium to long term. China boasts a multitude of developers with many being relatively small in scale. In this restructuring process, smaller developers may be phased out while high-quality developers stand to capture a larger market share. Real estate developers played an important role in China’s early economic growth story by offering employment, asset appreciation, and industrial activities. However, in our view, the real estate sector did not produce significant commercial or productivity value in terms of unique intellectual property, nor industrial know-how, such as what we’ve seen with the semiconductor manufacturing industry in Taiwan or the EV industry domestically in China. We believe that diverting resources away from an excessive reliance on property investments will facilitate the allocation of capital and effort toward more sustainable growth avenues and productivity-enhancing economic activities. Historically, banks favored allocating loans to developers rather than small- and medium-sized enterprises. The long-term consequence of these reforms is expected to be a more diversified business landscape and a robust capital market that fuels the organic economy growth.

Secondly, although state-owned enterprises (SOEs) exert substantial influence over China's economy, perpetuating the impression of "State Progress, Private Retreat," we believe the competitive landscape in China remains far from static. In fact, our observations indicate that China continues to exhibit remarkable dynamism and competitiveness, giving rise to globally competitive companies across various advanced industries. These industries span medical equipment, advanced manufacturing and machinery, electric vehicles, and lithium battery manufacturing, among others.

Lastly, concerns about youth unemployment in China, often cited as a harbinger of impending economic challenges, may in fact indicate that regulatory crackdowns on platform economies are approaching their end. A thriving platform economy holds paramount significance for China's future, as a significant portion of its young workforce aspires to participate in this sector. The potential return of vitality to this segment suggests resilience in the Chinese economy and aligns with the nation's aspirations for technological and entrepreneurial prowess.

To conclude, navigating China's economic landscape requires delving beneath the surface, where the complexity and depth of the market reveal opportunities that defy prevailing narratives. As contrarian investors, we recognize the potential for high returns by identifying undervalued assets poised for resurgence. Despite the current challenges, China's constantly evolving competitive landscape and aspirations for technological leadership underscore the compelling investment opportunities hidden beneath the surface.

Expert

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