China: a disappearing asset class?

Straight to the point: does China still have a place in a global portfolio?

Let’s face it: today, China is persona non grata and has practically disappeared from international portfolios. While flows are positive in emerging markets, with $30 billion in 2023, they are negative in China.

China evokes a very bad memory for international investors: Japan in the 1990s. Demographics are unfavorable (the third child policy is a failure), the country is indebted and the credit risk associated with the real estate sector is high. Developer debt represents 16% of GDP, and a write off of 50% would have an impact of about 8 GDP points. Consumer confidence remains at a historically low level and the Chinese continue to accumulate savings as a precaution, which looks like the beginning of deflation.

To this must be added the geopolitical risk of heightened Sino-U.S. tensions and the fear of a conflict in Taiwan. Exports, which remain one of the main drivers of the economy, are suffering from the effects of US restrictions, in addition to the slowdown in global activity. Made in China has fallen from 21% of total US imports in 2018 to 15% in 2023, to the benefit of countries such as Mexico and Vietnam. And India is only just getting started….

The latest figures on economic activity are disappointing, and the post-Covid rebound has not materialized. The real estate sector continues to generate problems. And the apparent good health of the automotive sector is mainly due to electric and hybrid vehicles, which already account for 33% of the market and are partially subsidized.

Is the 5% growth target set by the government sustainable?

In May, the consensus among economists was 5.7%, which, for once, exceeded official forecasts. Since then, expectations have declined, and the consensus is now 5.07%.

Is there a glimmer of hope?

In GemEquity, our global emerging markets fund, China represents 30.4% versus 29.7% for our benchmark, a prudent overweight.

To paraphrase Cervantes, where there is life, in theory there is hope!

1. In the United States, the bipartisan consensus against China is well established. It will not be a central issue in the upcoming presidential campaign, as voters have other concerns. Let’s not forget that U.S. companies sell $500 billion worth of goods to China, compared to $200 billion worth of imports. There is a limit to everything.

2. Regulatory change in the Internet sector has frightened – and rightly so – investors since October 2020. Why be a shareholder in companies when politicians can decide at any time on profits and their distribution? Since then, Beijing’s rhetoric has changed and this year there have been some signs that its attitude is now favorable.

3. The government reacts to the real estate risk by reducing by ten percentage points the down payment required from the first buyers, and even more in the case of a second apartment, by lowering the mortgage rate by 50 to 70 basis points, by converting part of the stock into social housing and by assuming the debt of the state-owned enterprises. At the Politburo meeting last July, the speculative dimension of the sector was no longer mentioned.

4. Business confidence rose to 49.7 in August, up from 49.3 the previous month. Both the manufacturing PMI (51) and the services PMI (51.8) surpassed the 50-point barrier. Inflation is approaching historic lows. The government is pursuing a business-friendly policy. Unlike in the West, the PBoC (central bank) is pursuing an accommodative monetary policy to stimulate activity. Recovery is fragile, but there is recovery.

At a market P/E of 10, expectations for corporate earnings growth are zero. Sectors such as the Internet, pharmaceuticals and manufacturing have seen their valuations more than halved. Many stocks are trading below cash per share. Macroeconomic risks are discounted. With China absent from major funds, the flow of sales should dry up.

Twelve months later, there are rays of hope! In a global portfolio, stocks such as Alibaba, Tencent and BYD are once again welcome.

Translated by DeepL.