On the one hand, it is a market that is simply too big to ignore. As J.P. Morgan’s view on Chinese assets argues, the biggest risk for investors would be to ignore them. But at the same time, the severe Covid restrictions, a regulatory clampdown that started 18 months ago, and a raging war in Europe have dampened foreign investors’ appetite for Chinese equities and bonds, at least in the short term.
Add to those the diverging monetary policy between the United States and China – tightening in the US and loosening in China – which has reversed the yield differential between 10-year US treasuries and CGBs (China government bonds). The portfolio outflow since February 2022 in anticipation has weakened the Chinese yuan relative to the US dollar – which depreciated by more than 5% since a month ago.
This week, BlackRock, the world’s biggest asset manager, downgraded its view on Chinese equities and CGBs from overweight to neutral, citing macro headwinds. For CGBs, it is the first time it has done so since it began tracking them in September 2021. In addition, it says that “China’s ties to Russia also have created a new geopolitical concern that requires more compensation for holding Chinese assets”.
Taking a different view, Credit Suisse lifted its outlook to overweight on Chinese equities in late March 2022. It is similar to the stance taken by another Swiss bank, UBS, which retained Chinese equities as the most preferred market in its May 2022 Investing in Asia report, while maintaining a neutral stance on CGBs.
At its Supertrends briefing on May 5, John Woods, Credit Suisse’s chief investment officer for the Asia-Pacific, says China’s massive infrastructure expenditure – part of the country’s transition to become carbon-neutral by 2060 – details of which he expects will be made public imminently, will trigger a “pretty powerful” market response.
“It is a vast, vast amount of money,” he points out, referring to the expected size of the infrastructure spend of some US$2.3 trillion, which is in addition to the previous announcement made a couple of years ago in the amount of US$1.4 trillion for digital infrastructure. “And it is being implemented potentially with an accelerated time line and a frontloaded spending schedule. Credit Suisse went overweight China just a few weeks ago with that anticipation in mind.”
Woods continues: “To get a sense of the scale, the fiscal and monetary stimulus that China injected into its economy immediately after the GFC [global financial crisis in 2008/2009], which went a long way to reflate the global economy, amounted to US$600 billion. This infrastructure package is 5x to 6x larger. It gives you a sense of how important infrastructure spending more broadly around China is being taken.”
He expects the spend is going to be more of everything: smart, modern and new infrastructure spend and tilting towards new infrastructure – energy-efficient technology appliances, green and smart buildings, green building construction. Given its size, Woods sees this as also important for the global economy.
As the world’s second largest economy with interconnected global supply chains, what happens in China is being felt in the rest of the world. “The severe lockdowns in China’s major metropolitan areas have led to further supply-chain interruptions and continues to impact company operations all over the world, a theme frequently mentioned in earnings reports over the past week,” notes Geir Lode, head of global equities at Federated Hermes.
Allianz Trade, the Paris-headquartered trade credit insurer formerly known as Euler Hermes, has quantified this impact in a report in April 2022. “Slower Chinese demand implies an export shortfall amounting to US$140 billion for the rest of the world,” writes Francoise Huang, senior economist, Ano Kuhanathan, head of corporate research, and Pablo Espinosa Uriel, investment strategist at Allianz Trade, in a recent commentary.
“The export shortfall could rise to US$185 billion if our downside scenario materializes, and even US$345 billion in the worst-case scenario. Hong Kong, the US, Japan, South Korea, and Germany would lose out the most.”
On the supply side, Allianz Trade analysis indicates that a sudden stop in China’s industrial activity would pose risks to global output, especially in the electronics and automotive sectors. “Overall, it is estimated that US$1.3 trillion worth of Chinese inputs are used in the rest of the world with Japan, South Korea, Vietnam, India, and Germany the most exposed. We estimate that current domestic bottlenecks in China are likely to lead to 0.2pp rises in the y/y inflation rates in the US and euro zone in Q3, all else equal.”
Allianz Trade says it still expects global trade volume to grow by 4% in 2022 (versus 6% expected before the invasion of Ukraine). “Risks are clearly on the downside and depend on the situation in China.”
It is a view shared by Silvia Dall’Angelo senior economist, Federated Hermes, a global manager with over US$631 billion under management. “The zero-Covid policy is likely to remain a drag on domestic demand for the foreseeable future,” he points out. “China also faces headwinds coming from high commodity prices, the war in Ukraine and the potential for secondary sanctions, and a possible sharp slowdown in Europe (a fifth of Chinese exports head to the euro zone)”.
Investors who remain positive on China are watching with eagle eyes what the Chinese government is going to do next, especially following President Xi Jinping’s directive on economic policy, which is to focus “on boosting technology and infrastructure while also relaxing regulatory oversight of the property market”, observes Mike Shiao, chief investment officer, Asia ex-Japan, at Invesco. “Private enterprises, especially technology, platform and infrastructure sectors, could ride on the policy support and boost domestic demand through initiatives such as consumption vouchers."
“Valuations of Chinese stocks listed on the Hong Kong stock market are cheap versus the US market – these companies are supported by structural growth drivers,” he adds. “For example, China internet companies are at a 32% discount to US internet companies. It shows a relatively cheap valuation and more attractive currently, especially following the latest positive development by Chinese policymakers.”
When concrete actions emerge to support growth, these will have an important bearing especially on China’s 2022 GDP growth. “I think about it probably 24 hours a day,” says Credit Suisse’s Woods on the details for the infrastructure plan. Federated Hermes’ Dall’Angelo indicates that pessimism is widespread: “Overall, it’s unclear whether the government will be able to achieve its 5.5% growth target this year. Scepticism is broad-based: the IMF also expects China to miss its growth target and expand by 4.4% this year.”
Woods is more hopeful. He expects details of the spending plan to be announced “sooner rather than later. In fact, I would even go as far as saying it will have to be in the next two months. If you look at the typical lag between an infrastructure investment and actually showing up in the national accounts, it would take around four to six months; which is another way of saying that if the government wishes to engineer a reasonably well functioning economy by the fourth quarter, then that spend has to be made pretty imminently – between now and some six to eight weeks.”
Decarbonizing China’s economy while ensuring uninterrupted growth represents perhaps one of the country’s most formidable challenges, he reckons. “Investors and analysts such as myself are very much focused on government announcements and policies that are released on a regular basis with the environment and climate change at its heart. Over the next 40 years, we are going to see one of the most extraordinary transitions in the history of major economies in centuries. That holds out the prospects of multi-decades investment opportunities.”
To get a sense of what’s next in China investing, The Asset Events+ is hosting the 17th Asia Bond Markets Summit, China edition – Rebalancing in the transition journey – on the 17th of May 2022. Panellists include experts from the Asian Development Bank, BlackRock, China Chengxin International Credit Rating, Moody’s Investors Service, PineBridge Investments, and UBS Global Wealth Management. To participate in the discussion and for more details, please click here.