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China: The unloved trade

market snapshot

5 April 2024 |
Active ESG
Whisper it quietly but, despite a sea of negative sentiment, equities in the world's second largest economy have held their ground in recent months. Could the contrarians be onto something?

Fast reading

  • The MSCI China Index traded flat for Q1 overall but is well off its early-quarter lows, gaining 10.6% since the end of January.1
  • A Bloomberg poll of 66 economists has upgraded China GDP and export growth forecasts for 2024.
  • The Caixin/S&P Global manufacturing Purchasing Managers Index rose to 51.1 in March from 50.9 in February, marking the fifth consecutive monthly expansion.
  • Outside of China, markets mostly trod water as investors awaited the next round of central bank updates and key economic data.

Investors looking for a contrarian play beyond the headline-grabbing tech rally narrative could do worse than consider the recent performance of China’s equity markets. That’s the message of Sandy Pei, Portfolio Manager, China Equity and Asia ex-Japan, who notes the MSCI China Index has come off its January lows and is now back in positive territory year to date.

Here, says Pei, a key factor has been the recent increase in shareholder returns through dividends and buybacks, initially at state-owned enterprises but increasingly at privately owned companies too. “Not only do these returns provide strong valuation support but they also make a compelling case for equity investment in a rate-cut environment,” she says. “It’s worth bearing in mind that while other countries are facing inflation, China is witnessing deflation. This makes equities attractive for domestic investors when compared against bank savings and so could provide additional future support for the market.”

Intervention by the Beijing government and regulators is also beginning to provide a backstop for markets, according to Pei. Most notably, the monetary easing and selective fiscal provision put in place from the end of 2023 has started to take effect and there are signs of sequential improvements of macro data.

Figure 1: There and back again – The MSCI China Index since December

But there are also other longer-term factors investors are ignoring at their peril, says Pei. “First, while Chinese companies are known for their cost competitiveness, they are also becoming a lot more competitive in terms of product design and innovation, most notably in the auto, smartphone, home appliance and renewables industries,” she says.

“At the same time, although Chinese brands are outperforming domestically, they are also making inroads into international markets despite geopolitical tensions and numerous regulatory hurdles. You can see this in the electric vehicle market, for example, where Chinese brands are gaining market share in parts of Asia, the Middle East and Latin America.”

The Caixin/S&P Global manufacturing PMI rose to 51.1 in March from 50.9 the previous month, above analysts’ forecasts of 51.0 and marking an expansion for the fifth consecutive month. (The 50-point mark separates manufacturing sector growth from contraction.)

Firm foundations or a short-lived step up?

Looking beyond China, markets largely trod water this week as investors awaited the latest leg-up or leg-down in response to central bank prognostications.

The S&P 500 dropped 1.6% for the week, the FTSE 100 gained 0.1% and the DAX lost 0.7%. The Nikkei 500 was the week’s main laggard, falling 3.4%.

For Linda Duessel, Senior Equity Strategist at Federated Hermes, the past few weeks have been all about a rotation into cyclically sensitive areas of the market such as industrials, materials, financials and energy. Meanwhile, she says, the AI-driven tech rally shows no sign of slowing down, with more than US$1bn being traded in leveraged Nvidia funds daily, while the five largest firms in the S&P 500 account for more than a quarter of the index.

For Duessel, however, the bigger question is whether the market is really healthy and whether current highs represent a potentially short-lived evanescence. Here, the data suggests the current rally is on a relatively firm footing.

“Operating margins on a forward basis now stand at 16.9%,” she says. “Other than the post-Covid period, that’s the highest level since 2008. Insofar as longevity can guide us, the eight previous bull markets have lasted from 132 days to 3,894 days, with an average of 1,228 days. The S&P 500 only regained its lost ground on January 19, so by that standard it could have quite a ways to go.”

For further information on our China Equity and Asia ex-Japan strategies please read our capabilities pages here and here.

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