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Our long-term view on China as a large opportunity for active investors remains constructive. However, the disruptions in the Chinese economy and markets have been more challenging—and have lasted longer than anticipated.

Volatility was sharp immediately after President Xi Jinping secured an unprecedented third term at the 20^th Party Congress on October 23. Investors punished Chinese companies over concerns about Xi’s choice of members for the Politburo Standing Committee and perceived turn away from pro-business and pro-growth policies. Reports of stronger-than-expected economic growth in the third quarter were pushed aside.

As a new top leadership team takes over, however, the new government seems to have turned its focus on the economy, making important policy adjustments and plans for the next five years. In a dramatic reversal, markets bounced back. At first this was driven by rumors of officials weighing a gradual exit of its zero COVID policy, and then by Beijing’s move toward shorter quarantine time for inbound travelers and a more targeted COVID control regime, despite weakening exports and retails sales readings. A comprehensive package to stabilize and support the real estate sector also provided a big boost to sentiment.

The zero COVID policy has been the main factor influencing Chinese stock performance in the past 12 months. The negative impact of widespread lockdowns on the economy and markets is clear. The latest easing moves gave markets hopes that China is at a critical moment and in transition to a scaled back and more flexible approach despite the significant rise in case counts in many major cities during recent weeks. We think steps towards a reopening in China could accelerate, and the forward-looking trajectory into next year now appears much more encouraging despite likely challenges ahead.

A 16-point real estate plan was jointly announced in November by the People’s Bank of China (PBOC) and China Banking and Insurance Regulatory Commission (CBIRC) and included measures such as cuts to mortgage down-payments, maturity extensions of development and trust loans, as well as others.

The plan is a departure from the more piecemeal approach of the past months as policymakers broaden support to the ailing sector and extending support to its value chain. The further expansion of bond guarantees for Chinese property developers should also be positive for market sentiment in the near term. That said, a successful implementation of the expansive plan would be key in reviving property sales—the most indicative benchmark for a sector recovery—and expectations and confidence to buy will take time to rebuild. It will also be dependent on the continued easing of the COVID policy.

It is premature to appraise the current term of the Xi presidency—as well as the new leadership team—and their effect on the China economy and markets. However, President Xi’s ideology will no doubt have unmatched influence over the country’s development and direction. Based on his public statements, he appears partial to sectors producing more ‘tangible’ goods and services such as manufacturing and technology, and that asset bubbles are more likely to come from an economy dominated by large financials and property sectors.

While certain industries may remain out of favor, as investors we consider all the different forces at play. Even if financials and property sectors are not seen as key drivers of the Chinese economy, they are an essential part of the economy and serve the needs of the vast majority of the people. We will continue to be interested in the survivors with strong balance sheets, who could be positioned to gain more market share.

Our investment strategies are centered on industry leaders, and policy tightening in the past two years have had a larger negative impact on industry leading companies. Given time though, we hope many will rebound. We have long focused on industry leaders because of their economies and efficiencies of scale, network effects and long-term potential. That said, we have adapted our long-held investing framework to be more multidimensional and balanced. We have diversified the different risks, including policy risk, by investing across several companies and industries. However, a China focused strategy will be more susceptible to factors adversely affecting issuers located in China than would a more geographically diverse portfolio of securities. In addition, a China-focused strategy may invest in a smaller number of issuers and be less diversified than some other strategies which could cause it to be more volatile. Despite the risks, we continue to believe that high quality companies with strong competitive advantage—and the determination to transition and adapt to the current regulatory climate—could deliver results in the long run.

Investors should also pay attention to the investment price. For example, the market focused on computer hardware, driven by President Xi’s vision to achieve self-sufficiency in semiconductor manufacturing, valuations have priced in 10 years of high growth. Yet it would be unrealistic to expect a linear upward path. When valuations and expectations are this high, investors should be cautious.

The US’s prior sanctions against Huawei did not create significant damage to the sector. This time though, the US has taken action against all advanced chips for China, particularly those used for advanced artificial intelligence. However, since China is the largest customer of the US chip companies, this also hurts the US. That is why we have seen declines in US semiconductor company stocks. Although geopolitical tensions remain high, US President Joe Biden and President Xi met recently during the G20 meeting in Indonesia and the statements out of the meeting seemed to point to a softening in the rhetoric, even if not on specific issues in the US-China relations.

Valuations are inexpensive

12M forward price-to-earnings ratio (P/E)

Source: FactSet, MSCI, ÃÛ¶¹ÊÓƵ Asset Management. Past performance is not indicative of future results. As of end October 2022. This information should not be considered as a recommendation to purchase or sell any security.

Despite the recent rebound in China markets, valuations remain very low. And there are clearly many factors that have contributed to this, leaving investors on the sidelines. Should strong actions continue to come from the government, equities have significant room to re-rate. More importantly, China remains one of the largest opportunities for active management, which makes us constructive on Chinese equities for the long term.