China: Suspended Animation

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Summary

  • After weakness tied to Shanghai lockdowns in April and May, the Chinese economy and capital markets rebounded rapidly as the economy reopened.
  • Adjustments to epidemic prevention and control policies, more comprehensive economic stimulus, and fresh social spending are all possibilities.
  • Should there be a sustained recovery next year, as we expect, higher-quality names would likely have opportunities, and the current pause in policy could turn out to have been an appealing window of opportunity for equity investors.

China Real estate Evergrande bankrupt

Marcos Silva

By Ning Meng

The run-up to China's leadership meetings this fall is delaying substantial policy changes, in our view creating opportunities in advance of potential economic improvement next year.

Today's CIO Weekly Perspectives comes from guest contributor Ning Meng.

Much of the world has recently focused its attention on Taiwan-related tensions, but there are multiple reasons why 2022 has proven so eventful for China, including extended lockdowns in accordance with the country's "zero-COVID" policy and a seeming wait-and-see approach as authorities ready for the crucial Communist Party Congress, likely scheduled for the autumn.

Slower Growth, Policy Stasis

After weakness tied to Shanghai lockdowns in April and May, the Chinese economy and capital markets rebounded rapidly as the economy reopened. But China continues to adhere to its dynamic zero-COVID policy, as closures were executed in multiple cities based on local outbreaks. This helped to slow the expansion, leaving the pace of annual economic growth at about 2.5% for the first half of the year versus the annual government target of 5.5%, and helped send the MSCI China A Index down 15% year-to-date through July.

In addition, the lack of new economic stimulus from the country's Politburo meeting in July signaled that the Chinese government was likely to focus on ensuring a smooth political transition in the fourth quarter rather than fully stimulating the economy. The government has made some significant moves, including pausing its crackdown on internet and technology companies. But, overall, authorities are very cautious about taking major missteps such as experiencing a resurgent pandemic or reigniting property speculation. Thus, we believe that economic policies in the coming months are likely to be in reaction to specific issues, for example, providing loans to shore up property developers subject to mortgage boycotts (where borrowers are refusing to pay interest until their properties are actually constructed).

Volatility - but Appealing Valuations

The net result, in our view, is a China that is likely to face softening fundamentals and limited policy support over the near term. Amid broad economic weakness, many investors have crowded into the "new energy" sector, which is benefiting both from government support and substantial demand from Europe, which is working to increase energy independence from Russia in the wake of the Ukraine conflict. This has created major dispersion in valuations, with new energy names often reaching very high multiples, compared to single digits or low teens for many more traditional companies. Based on our experience, similar valuation dispersions have often contributed to market volatility, and we see the potential for continued weakness in China markets for the rest of 2022.

The silver lining, however, is those policy stances that have contributed to slow growth could easily be moderated - something that we think is likely to happen once the leadership transition is completed toward year-end. Adjustments to epidemic prevention and control policies, more comprehensive economic stimulus, and fresh social spending are all possibilities.

In this context, we are confident in the fundamentals of the new energy names, but wary of their valuations in the short term. In contrast, we are finding many high-quality companies with what we consider appealing valuations, particularly those focused on consumption, health care, finance and advanced manufacturing. Should there be a sustained recovery next year, as we expect, higher-quality names would likely have opportunities, and the current pause in policy could turn out to have been an appealing window of opportunity for equity investors.

In Case You Missed It

  • China Consumer Price Index: +2.7% year-over-year in July
  • China Producer Price Index: +4.2% year-over-year in July
  • U.S. Consumer Price Index: 0.0% in July month-over-month and +8.5% year-over-year (Core CPI increased 0.3% month-over-month and 5.9% year-over-year)
  • U.S. Producer Price Index: -0.5% in July month-over-month and +9.8% year-over-year
  • U.K. 2Q 2022 GDP (Preliminary): -0.1% quarter-over-quarter

What to Watch For

  • Monday, August 15:
    • Japan 2Q 2022 GDP (Preliminary)
    • NAHB Housing Market Index
  • Tuesday, August 16:
    • U.S. Housing Starts and Building Permits
  • Wednesday, August 17:
    • U.S. Retail Sales
    • FOMC Minutes
    • Eurozone 2Q 2022 GDP (Second Preliminary)
  • Thursday, August 18:
    • Eurozone Consumer Price Index
    • Japan Consumer Price Index

- Investment Strategy Group

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