Our Fingers On The Pulse

Over the past several months, we attended the flagship China conferences hosted by several global investment banks and conducted on-the-ground channel checks in multiple tier 1 and 2 cities as well as speaking with management from diverse sectors to obtain a holistic view of China’s post-COVID recovery.

With our HOKA sneakers having to endure 20,000+ daily steps, our conclusion on China’s investment outlook is rather mixed.

While we are positive about the recent effort to stabilize the Chinese equity market, provide longer-term liquidity to the banking system, and loosen property policies in several key cities, we expect that China’s post-covid recovery could be a long and gradual process and that a structural bull market is unlikely to materialize without a more robust measure from the central government.

Several points worth considering:

First, many of the policies that have been issued appear to be reactive rather than proactive, designed to address near-term challenges while not materially addressing the fundamental challenges around the property sector, local government debt, rising capital market pessimism, and business and consumer confidence. The supply-side measures so far have limited effects in addressing the near-term economic softness, and we would be more positive on the outlook if/when comprehensive demand-side measures are incorporated into the economic stimulus. For the past six months, we have yet to see such a measure materialize, and it remains unclear whether demand-side stimulus, if any, is part of the recovery playbook.

Second, the corporates that we met all have toned down their expectations for 2024, which was a stark contrast to their view in the middle of 2023 when they were very optimistic about the trajectory of the post-COVID recovery. In light of a soft macro environment, consumer spending, and business sentiment, company management all appear to have come to accept the near-term revenue challenges and are actively looking to cut costs to maintain profitability. Companies with large domestic revenue exposure were largely cautious regarding 2024’s outlook while those with global exposure were more optimistic.

Finally, the sentiment gap between onshore investors and offshore Chinese investors is narrowing. Six months ago, domestic investors were largely bullish on China’s economic recovery driven by incremental policy support while the offshore investors, most notably the US and European-based funds, have been underweight China due to both economic and geopolitical overhang. Our recent conversation with onshore investors is that the sentiment gap is narrowing, with some local investors appearing to be more bearish than offshore investors.

All in all, we are cognizant of China’s near-term challenges including what appears to be a deflationary environment, elevated youth unemployment, and diminishing wealth effect in both housing and income, but we still believe the current low valuation level offers compelling investment opportunities for a few select themes. Worth noting that we do not believe that low valuation should not be the sole determinant of investment decision-making criteria. What matters the most to us is the company’s ability to become competitive in the global arena and/or capture secular themes to provide solid Free Cash Flow for shareholders.

We prefer three themes that have the potential to outperform amid a cautious macro environment, namely selective consumption, overseas expansion, and limited geopolitical risk.

Selective consumption has been a major theme amid a cautious consumption environment. While some may argue that Chinese consumers may have “downgraded” their consumption habits, we would argue that consumers are becoming more value-oriented and practical with their spending. Defensive names in the education and telecommunication sector offer both value and growth to investors in a soft macro environment. For the telecommunication sector, the valuation remains attractive while offering investors with 6-7% dividend yield, while the education sector continues to see strong demand due to soft job market and the increasing desire for students to prepare for overseas studies. China Unicom and New Oriental are two potential outperformers under this theme.

Considering the highly competitive domestic market, overseas expansion is becoming an increasingly important theme for many Chinese companies. Although we view the current Chinese EV competitive environment as that of Android smartphones 10 years ago (ie. Limited hardware differentiation, questionable value on advanced features, competitive pricing), we are quite positive about their ability to compete globally given their superior value proposition against the overseas incumbent automakers or the global EV brands. While we acknowledge that the US and Europe could pose some geopolitical risk in the near term, we also believe that exports to the Middle East, Russia, and ASEAN nations could offset this weakness and drive long-term growth for the Chinese automakers. On a recent trip to Turkey, UAE, and Saudi Arabia, it was refreshing for our analyst to see Chinese EVs on the road. The positive feedback at the dealership reinforces our conviction on this directional trend.

Finally, globalization is not without geopolitical risk given the current sentiment towards China. We believe that companies that operate in the so-called strategic sectors (ie. High tech, AI, semiconductor, biotechnology, power transition) are most vulnerable to geopolitical shock, while the less strategic sectors (ie. Retail) may face limited downside risk. We are positive about the prospect of Chinese ecommerce companies such as PDD, Shein, and ByteDance going global by leveraging China’s efficient supply chain and offering value for money to global consumers. Given that the retail sector is widely considered not strategic relative to the more strategic sectors we pointed out above, we believe companies within this theme can capitalize on the frugal luxury consumer base at the global scale while facing limited geopolitical shock.

Last but not least, we would like to share our thoughts on navigating what many investors consider “China’s new norm”. A proven investment framework is the product of decades of experience through various economic and investment cycles that allow fund managers to continuously refine their acumen through self-reflection and leverage both macro and micro input generate consistent return. China enjoyed a period of rapid economic growth, and the current dynamic implies that the country may be entering a period of slow, but more sustainable, growth trajectory. Understanding this economic transition and having the relevant expertise in navigating investment cycles may prove to be advantageous in the current environment.

At 瀚嘉资产管理有限公司 , our seasoned investment professionals have experienced multiple cycles over the past two decades in both developed and developing markets, and we are proud to leverage this global perspective to deliver value to our clients.

In light of the holiday season, we would like to wish all of our friends, families, and clients a Happy Lunar New Year and all the wealth and success in the Year of the Dragon!