Question 1

An uneven recovery has the potential to surprise on the upside

Accepted Answer

While China’s economy experienced a strong bounce in the fourth quarter of 2022, its recovery so far this year has not been as strong as anticipated. The recovery process will likely come in phases and depend on factors such as the property market, which has performed patchily across different cities in China.
For export sectors, the recovery will probably not be as strong, but it is not expected to collapse. Exports performed better than expected during the first quarter of 2023, led by the electric vehicles (EVs), solar panels and battery segments. China is now the largest automobile exporter in the world. Several Chinese EV brands are experiencing strong growth outside China.
Chinese automakers are pushing ahead of the global brands, spending aggressively on R&D and introducing new technology and features. We believe it is a matter of time before customers outside of China realize that the Chinese brands can offer better cars at better prices.
Health care companies are also becoming globally competitive, partly because conducting R&D is cheaper in China. We are seeing more licensing out from Chinese pharmaceuticals companies instead of licensing in from global companies.
In general, we are constructive on the technology sector and the internet names in China, because we think the fundamentals are positive. Online gaming companies are doing better than expected, and advertising revenue is expected to recover as the economy recovers.
The peak for the property sector is probably in the rearview. Structurally, we take into account that population growth has slowed and square footage per person has already increased substantially over the years, so we expect the sector to stabilize at a level below its peak. However, we see that home improvement demand is still sizable, which can support the overall demand and prices.
We believe many of the industry-leading companies can still deliver 15-20% earnings growth by controlling expenses and expanding into international markets.

Question 2

More could be done to improve consumer and business confidence

Accepted Answer

Consumption in China has rebounded strongly due to pent-up demand after lockdowns. But while growth is positive in many areas, spending on big-ticket items like automobiles alongside property purchases remain below expectations.
Super savings problem: Savings have increased substantially during the past few years, and they are not translating into long-term investments. This shows a lack of confidence in the general public as well as in some entrepreneurs. Private sector investment has been below par so far this year. Entrepreneurs are in a wait-and-see mode, not investing proactively to capture future opportunities.
We believe the Chinese government should roll out concrete supportive measures that are clear and can be interpreted and implemented without ambiguity . A firm and consistent direction from the government will restore business sentiment and encourage investment.

Question 3

The impact of geopolitical tensions and trade sanctions

Accepted Answer

Tensions between the US and China concern us. Nonetheless, we believe China wants peace and the two countries need to work together. They remain interdependent despite the talk of decoupling, which can be damaging for both countries.
The US CHIPS and Science Act and other sanctions will have a significant impact on certain individual companies, but other companies have come in to fill the gap, which muted the impact on the sector overall. Ninety percent of the semiconductors used in China are still imported; chips are the Achilles’ heel of the Chinese high tech industry. For example, the development of autonomous driving relies on imported chips. If those supplies are reduced sharply, it will hurt China, and at the same time US companies will also suffer because they will lose their largest customer.

Question 4

The rotation toward state-owned enterprises (SOEs) due to low valuations

Accepted Answer

SOEs were largely abandoned by the market before, which pushed them to extremely low valuations. Now we are seeing some stabilization of their top-line and earnings growth, and they pay attractive dividend yields.
However, SOEs also have their challenges, chief among them is that management’s interests are not 100% aligned with those of the shareholders. The goal of SOEs is to deliver stable growth and returns, so some are relatively slow-moving.
We believe the market will refocus on privately owned companies (POEs) after the valuation gap between POEs and SOEs narrows further.

Question 5

The best time to invest has been when investors feel the most uncomfortable

Accepted Answer

Even though generating alpha has become more challenging in the last three years, the Chinese economy is big enough. There are a large number of companies to choose from. It simply requires in-depth fundamental research to identify the next leaders.
Overall, global investors are neutral to underweight China. Many investors rode the recovery last year and rotated out in the first quarter of this year, taking their profits. It appears that global investors recognize the value in the China market, and they are waiting for a clear signal and positive catalyst to get back in.
Nonetheless, history tells us that the best time to invest has been when investors feel the most uncomfortable.

Question 6

An uneven recovery has the potential to surprise on the upside

Accepted Answer

While China’s economy experienced a strong bounce in the fourth quarter of 2022, its recovery so far this year has not been as strong as anticipated. The recovery process will likely come in phases and depend on factors such as the property market, which has performed patchily across different cities in China.
For export sectors, the recovery will probably not be as strong, but it is not expected to collapse. Exports performed better than expected during the first quarter of 2023, led by the electric vehicles (EVs), solar panels and battery segments. China is now the largest automobile exporter in the world. Several Chinese EV brands are experiencing strong growth outside China.
Chinese automakers are pushing ahead of the global brands, spending aggressively on R&D and introducing new technology and features. We believe it is a matter of time before customers outside of China realize that the Chinese brands can offer better cars at better prices.
Health care companies are also becoming globally competitive, partly because conducting R&D is cheaper in China. We are seeing more licensing out from Chinese pharmaceuticals companies instead of licensing in from global companies.
In general, we are constructive on the technology sector and the internet names in China, because we think the fundamentals are positive. Online gaming companies are doing better than expected, and advertising revenue is expected to recover as the economy recovers.
The peak for the property sector is probably in the rearview. Structurally, we take into account that population growth has slowed and square footage per person has already increased substantially over the years, so we expect the sector to stabilize at a level below its peak. However, we see that home improvement demand is still sizable, which can support the overall demand and prices.
We believe many of the industry-leading companies can still deliver 15-20% earnings growth by controlling expenses and expanding into international markets.

Question 7

More could be done to improve consumer and business confidence

Accepted Answer

Consumption in China has rebounded strongly due to pent-up demand after lockdowns. But while growth is positive in many areas, spending on big-ticket items like automobiles alongside property purchases remain below expectations.
Super savings problem: Savings have increased substantially during the past few years, and they are not translating into long-term investments. This shows a lack of confidence in the general public as well as in some entrepreneurs. Private sector investment has been below par so far this year. Entrepreneurs are in a wait-and-see mode, not investing proactively to capture future opportunities.
We believe the Chinese government should roll out concrete supportive measures that are clear and can be interpreted and implemented without ambiguity . A firm and consistent direction from the government will restore business sentiment and encourage investment.

Question 8

The impact of geopolitical tensions and trade sanctions

Accepted Answer

Tensions between the US and China concern us. Nonetheless, we believe China wants peace and the two countries need to work together. They remain interdependent despite the talk of decoupling, which can be damaging for both countries.
The US CHIPS and Science Act and other sanctions will have a significant impact on certain individual companies, but other companies have come in to fill the gap, which muted the impact on the sector overall. Ninety percent of the semiconductors used in China are still imported; chips are the Achilles’ heel of the Chinese high tech industry. For example, the development of autonomous driving relies on imported chips. If those supplies are reduced sharply, it will hurt China, and at the same time US companies will also suffer because they will lose their largest customer.

Question 9

The rotation toward state-owned enterprises (SOEs) due to low valuations

Accepted Answer

SOEs were largely abandoned by the market before, which pushed them to extremely low valuations. Now we are seeing some stabilization of their top-line and earnings growth, and they pay attractive dividend yields.
However, SOEs also have their challenges, chief among them is that management’s interests are not 100% aligned with those of the shareholders. The goal of SOEs is to deliver stable growth and returns, so some are relatively slow-moving.
We believe the market will refocus on privately owned companies (POEs) after the valuation gap between POEs and SOEs narrows further.

Question 10

The best time to invest has been when investors feel the most uncomfortable

Accepted Answer

Even though generating alpha has become more challenging in the last three years, the Chinese economy is big enough. There are a large number of companies to choose from. It simply requires in-depth fundamental research to identify the next leaders.
Overall, global investors are neutral to underweight China. Many investors rode the recovery last year and rotated out in the first quarter of this year, taking their profits. It appears that global investors recognize the value in the China market, and they are waiting for a clear signal and positive catalyst to get back in.
Nonetheless, history tells us that the best time to invest has been when investors feel the most uncomfortable.

Key insights

An interim report card on China’s recovery

Thriving sectors and quality companies in China

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