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China’s new antitrust, data privacy and cybersecurity regulations, combined with its education and real estate industry reforms, the continued impact of COVID-19 and rising geopolitical tensions, drove a tumultuous investment environment last year. The country’s numerous headline-grabbing changes spurred global concern given the philosophical shift towards “Common Prosperity” and the sheer scale and speed of policymaking.
Looking ahead, we seek to interpret the events of 2021 in context. Regulatory shifts are not new in China, and, with the benefit of hindsight, there are clear reasons so many changes came so quickly. Critically, several structural drivers have helped the country’s equity markets globalise and appreciate during the past decade despite multiple periods of significant regulatory change. We believe those drivers will endure going forward.
In this piece, we address a common set of questions from clients following last year’s events, offering our perspective on the balance of risks and opportunities we see in Chinese public equity markets.
After the first half of 2021 brought an apparent inflection in the global pandemic and strong economic data, Chinese policymakers seemingly seized a brief window of opportunity to make their marks ahead of the 2022 National People’s Congress. The resulting barrage of new policies came as China’s GDP growth is structurally decelerating and transforming. Investment-led infrastructure and manufacturing growth is slowing while innovation, localisation and evolving consumption increasingly power the economy. This environment of slowing growth added to the pressure on leaders to address social issues such as the burden of after-school tutoring costs and income inequality.
China’s key areas of recent change and potential future investment risk are complex and multifaceted, creating significant associated uncertainty. Below, we offer a glimpse into how we put these issues into perspective as well as how we frame our base case looking ahead. We’ve provided links to more robust perspectives on many of these topics at the end of this article.
In our view, Chinese equities currently offer reasonable valuations, the likelihood of domestic policy support and the potential for lower correlations with other global risk assets. They have underperformed most other regions including the US, Europe and India since the start of the pandemic. Today, we believe Chinese equity market multiples appear reasonable relative to their own history while discounts to other key markets, such as the US, are near historical highs.
Importantly, unlike the developed world, the Chinese economy needed little stimulus in 2020 or 2021 amid the pandemic. In fact, the Chinese central bank’s balance sheet has been shrinking while the Fed’s expanded. It is now smaller as a percentage of GDP relative to that of its US peer. After emphasising reform in 2021, we expect the Chinese government to be both willing and able to support the economy this year. Notably, China faces less inflation pressure than the West and recently cut rates with room to move further. Taken together, we believe China’s economic cycle may exhibit limited correlation to that of the US and EU in the coming years.
Within this environment, we see several enduring areas of investment opportunity. Crucially, we do not believe that slowing GDP growth diminishes the return potential of Chinese equities. As US equities have demonstrated over the last decade, dramatic headline growth is not required for large economies to generate attractive equity returns.
China has one of the world’s largest and most dynamic economies. Regulatory shifts are part of industry development globally and are understood and expected within China. Looking ahead, we believe innovation, localisation and evolving consumption all generate exciting investment potential. The Chinese equity market — encompassing domestically listed A-shares, Hong Kong listed shares, US listed and traded companies and ADRs and other instruments — offers investors a broad set of potential investments. Not only is the opportunity set large and diverse, but retail participation in equity markets remains high, supporting abundant liquidity. We believe this environment creates an enormous opportunity for skilled institutional active management.
1Source: OECD, UNESCO, World Bank, Euromonitor, Ministry of Education of PRC, National Center for Education Statistics, Wind, UBS-S estimate
Past results are not necessarily indicative of future results and an investment can lose value. Funds returns are shown net of fees.
Source: Wellington Management
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