The Long and Short of it: Will a new China emerge and change the way of investing?

Key insights:

Despite a volatile equity market in the last 18 months and a slowing economy, we as a relative value investor look at the China situation from a very different perspective. The world’s second largest economy provides plentiful structural growth ideas – both long and short alpha – which makes China very investable in our book.
We see many opportunities in market share gainers and losers in sectors such as real estate, automobiles and technology. And Chinese companies are becoming more and more competitive in overseas markets and differentiating themselves as leaders.
That said, we have been proactively and systematically managing risks in this challenging environment. Our more conservative approach especially with long positions now involves stress testing for different scenarios of geopolitical tensions, further decline in the property market, and aging population.
There are recent signals from CPI, PPI, retail sales and total social financing (TSF) that the Chinese economy is improving. We believe more punchy stimulus from the government could have an amplifying impact on the most energetic part of the economy and help restore the loss in confidence.
We see attractive short positions in the renewable energy sector as oversupply keeps the sector in a down cycle that could last 12 to 18 months. Short opportunities also exist in healthcare as the beta play fades amid rising costs and anticorruption policy.
Although some structural issues with state-owned enterprises (SOEs) remain, we believe that the current round of policy reform to focus on profitability, corporate governance and investor relations is promising and could make SOEs more competitive and strengthen their returns in the long run. Additionally, their dividend yields are attractive and sustainable as China enters a low interest rate cycle in the medium to long term. A diverse set of opportunities can be found in metals and mining, healthcare, industrials SOEs in our view.
For generative artificial intelligence (AI), we look at large language models (LLMs), computing and networking, AI applications, and enterprise AI companies and try to identify long-term alpha opportunities. Potentially, short alpha could exist in many Chinese AI concept companies that have already missed investor expectations with lofty valuations, while long alpha may be found in companies developing LLMs with a strong commercial outlook.
We have become more constructive in recent months and are optimistic about a “new normal” for China in the long term. The current consensus bearish view is inconsistent with China’s trajectory of growth in our opinion, and as more meaningful government stimulus kicks in, the environment could become more favorable for upside surprise.