The sell-off in Chinese stocks this year as investors fret over the impact of the country’s zero-Covid policy and the risks presented by slowing growth mean that Chinese shares are trading at discounts unseen for more than two decades, according to fund managers at Federated Hermes.
Weakening sentiment has pushed the Hang Seng Index down more than 10% year to date as traders shun Chinese equities in the face of draconian lockdowns in a number of cities, including Shanghai, with the possibility of a lockdown in Beijing on the cards.
“If you look at relative valuations on the Hang Seng Index, Chinese shares have never been as cheap,” said Sandy Pei, deputy portfolio manager at Federated Hermes, during a presentation at the Federated Hermes Asia and Emerging Markets Investing Forum at the Pan Pacific London on 28 April.
Figure 1: Relative valuation of the Hang Seng Index vs. the MSCI All Country World Index
Source: Bloomberg as 31 March 2022.
Past performance is not a reliable indicator of future results.
The underlying fundamentals of the Chinese economy remain robust, Pei added, highlighting the growth of numerous Chinese companies – in sectors such as fashion, jewellery and technology – on the back of robust domestic demand and global expansion.
“Chinese consumer brands have been gaining share in the domestic market and, more importantly, they are gaining share in the mid- to high-end segment which has historically been dominated by multinational brands. There is long runway for consumption growth in China due to the high household saving rate and Chinese companies can capture more value add through continued share gains and upgrades,” Pei said.
“Chinese brand companies are also expanding globally with strong presence in smartphones and home appliances. They are also gaining momentum in the digital economy, in areas such as social networks, gaming and e-commerce.”
China’s share of global manufacturing, meanwhile, continues to increase despite global trade tensions. The country’s share of global manufacturing output has risen to about 30% as it shifts away from low-cost labour-intensive production to advanced manufacturing and the development of green technologies, where it is emerging as a world leader.
China does, however, face a number of risks, conceded Jonathan Pines, lead portfolio manager, Asia ex-Japan, Federated Hermes, speaking in the panel discussion. The country’s strict zero-Covid policy is difficult to exit, huge, heavily-indebted developer Evergrande looks to be heading for default with some fearing contagion; and common prosperity policies have left investors questioning authorities’ commitment to capital markets, Chinese US-listed American depositary receipts (ADRs), for example, might be delisted despite recent efforts by authorities to comply with US requirements.
“But the risk we worry about most is tension between the US and China because it’s the least predictable. We expect tensions to gradually escalate in the years to come, although we do not expect a significant escalation in the short- to medium-term,” Pines said.
“Stock prices have fallen to 30-year relative lows and more than discount these risks.”
The crisis in Ukraine may have led to a short-term surge in demand for fossil fuels but over the long-term the invasion will accelerate the global uptake of renewables and green tech because it’s the only way many politicians, particularly in democratic countries, will be able to mitigate the surge in the cost of living that many households around the world face, said Kunjal Gala, lead portfolio manager, global emerging markets, at Federated Hermes, also speaking in the panel discussion.
“The demand for metals used in renewable technologies will drive investment in Latin America in years to come,” Gala said, citing Peru and Chile in particular, home to 40% of global copper reserves.
“People can focus so much on the risks that they can overlook the opportunities. Over the longer term, we see significant opportunities across Asia and emerging markets, particularly related to renewables, digitisation and electrification.”
Other speakers at the event included Vivek Bhutoria, co-portfolio manager, global emerging markets at Federated Hermes, on the outlook for India; Olivia Lankester, director, responsible investing and sustainability at Federated Hermes on integrating ESG criteria into emerging market investing; and portfolio managers Mohammed Elmi and Nachu Chockalingam on emerging market debt. The keynote speaker was British journalist Tim Marshall, an expert on foreign affairs and international diplomacy.