The lifting of Covid restrictions has seen China’s economy rebound, though worries over regulation of the tech sector and the geopolitical situation remain
During the past two decades, the attention of the world’s economists has centred on Chinese growth numbers. Today, their gaze is more laser-focused than ever. Most wealth managers clearly welcome improving data, but they attach a health warning about longer-term prospects.
China’s first quarter 2023 GDP grew 4.5 per cent year-on-year, accelerating from 2.9 per cent in the final quarter of 2022 and exceeding market forecasts of 4 per cent. Retail sales were particularly impressive, growing 10.6 per cent in March, against 3.5 per cent in January to February, driven by broad-based post-pandemic “revenge spending”, as the economy expanded at its fastest pace in a year after the end of Covid-related restrictions.
“This data may dispel some of the concerns on whether China is recovering fast enough,” says Roger Bacon, head of investments, ultra-high net worth, Asia, at Citi Global Wealth Investments. “Low inflation suggests additional policy support, and together with a slight tone improvement to the geopolitical backdrop, may lead to upwards earnings revisions and a valuation re-rating.”
Key to the latest upturn has been Beijing’s decision to loosen stringent pandemic restrictions, which not only hampered business transactions, but also depressed the collective spirit of China’s citizens, who saw on TV that their counterparts in other countries were leading a relatively unencumbered existence.
I think the willingness to travel has come back dramatically and the sentiment has been extremely good from a markets perspective -
“When you think about our peak number of visitors here in Hong Kong, we had 140,000 a day back in 2017,” says Mr Bacon, describing how numbers plunged, first due to a prolonged period of demonstrations in 2019, then followed by the Covid pandemic the following year.
“We are back in very good shape now that the border points have re-opened,” he says, looking out of his 50th floor window from Citi’s building in Garden Road, across the water to Kowloon, watching ferries heading to Macau and other cities in the booming Pearl River Delta. “I think the willingness to travel has come back dramatically and the sentiment has been extremely good from a markets perspective.”
A veteran of many cycles and crises in Asia, Mr Bacon combines an energetic enthusiasm for the region’s growth prospects with a note of caution. His conversations with clients involve a balancing act of tempering their gung ho approach of previous eras, while still providing sufficient market access.
“When we’re evaluating how our clients should be exposing their portfolios to China, the debt and real estate markets are important factors, particular for those clients who have fixed income positions, because some specific names out there are having restructuring situations, which are still ongoing,” he says.
A more proactive approach by regulators has helped accelerate recent restructures. “All that leads to more positive sentiment, but it doesn’t mean there won’t be problems,” cautions Mr Bacon.
Pearl River Delta
“China's economy is recovering faster than expected, thanks to termination of the zero-corona policy, prevention of the outbreak by achieving herd immunity, and a strong policy response,” says Maggie Sun, Shanghai-based senior portfolio manager at Sumitomo Mitsui DS Asset Management. “We believe the Chinese economy will continue to stabilise and this will be a supportive factor for the Chinese domestic and Asian stockmarkets.”
Two major risk factors are highlighted by Ms Sun. “The first is weak external demand, particularly in the US. Weakness in US manufacturing could be a drag on Asian exports, including China. The second is slow recovery of domestic employment, which may delay recovery of consumer sentiment and slow consumption.”
Key to the future of China’s economy is the prognosis for the technology sector, located predominantly in southern cities including Shenzen at the heart of the Pearl River Delta, where big techs including Tencent, ZTE and Huawei are based.
Although the re-appearance of Alibaba founder Jack Ma is seen as predominantly positive, previous crackdowns on high-tech innovators are viewed as part of a longer-term strategy from Beijing. The subsequent division of Alibaba into six separate units appears to provide further evidence of this.
“Since the concentration of power in the hands of president Xi Jinping was strengthened at the party congress last autumn, we can expect a more top-down policy management. In that sense, we do not believe that the risk of increased regulation for platform companies like Alibaba is already gone,” says Ms Sun.
“On the other hand, we believe the aim behind the previous tightening of regulations is to crack down on monopolies and business forms that adversely affect the lives of citizens, and in this sense, the objective of the regulations on major platformers has already been achieved.”
Platforms lead the way
China's authorities believe these high-profile “platform companies” will play a central role in the development and innovation of Chinese society and economy in the future. This means they are unlikely to stand aside and let these firms develop of their own volition. Ms Sun believes the authorities will “take a policy stance to support the development of tech companies including platformers and regulate them as necessary”.
Most commentators argue the government has clearly defined its agenda to support “common prosperity” and curtailment of monopolies, with the break-up of Alibaba central to this policy. Moreover, pursuit of higher quality growth with focus on technology advancement and self-sufficiency is expected to shift investment to newer emerging technologies.
HSBC expects more Chinese internet companies to explore similar business restructuring and spin-off plans, unlocking significant value compared with current deep discounts. The “policy pivot” on the digital platform economy, argues the bank, is instrumental for the government’s “growth stabilisation” goal. This is vital for a private sector accounting for more than 60 per cent of national economic output, 70 per cent of technological innovation and 80 per cent plus of urban job creation.
Blue chip Chinese internet leaders with strong profitability and potential business restructuring and fundraising opportunities are likely to be particular favoured by wealth managers.
“This signals that the regulatory storm is approaching its end,” says Tam Tsz-Wang, telecom, media and technology analyst for DBS Group Research. “The split up of the ecosystem also means Alibaba is giving up potential monopolistic practice in the future, echoing the regulator’s mission. We should see internet platforms focusing on their own core businesses, and less conglomerate-giants. This supports healthier industry development in the long term.”
We should see internet platforms focusing on their own core businesses, and less conglomerate-giants. This supports healthier industry development in the long term -
But not all market participants are convinced. “The ramifications of Alibaba's revamp are still unfolding,” reflects Chi-Man Kwan, group CEO and co-founder of Raffles Family Office in Hong Kong. “It is unclear whether this event represents a continuation of the Chinese government's agenda to reorganise tech companies and dismantle sizeable monopolies, or if it signifies a conclusion to the intense regulatory scrutiny. Coupled with geopolitical risk that is here to stay for the short- to mid-term, many clients continue adopting a wait-and-see approach to increase allocation to China investments.”
Geopolitical tensions
The other key factor affecting long-term health of Chinese and broader Asian markets is the trade relationship with the US, currently micro-analysed by wealth and asset managers, searching for long-term patterns.
“While political tensions are rising, economic ties between the US and China, China and Taiwan are extremely strong, and we believe the situation in which both sides need each other will not change in the medium term,” says Sumitomo’s Ms Sun. “From the standpoint of national security, we believe export restrictions on high-tech products, particularly semiconductors, by the US to China will continue, and that China will proceed with its own manufacturing over time by receiving strong support from its government.”
How Asian companies have reacted to escalating geopolitical risk around Taiwan, by re-adjusting export models, has also impressed investors. “Companies have tried to mitigate this risk by diversifying production and supply chains,” says Chetan Sehgal, director of portfolio management, Franklin Templeton Emerging Market Equity, based in Singapore. He points to major investment expected for artificial intelligence (AI), a key growth driver for the semiconductor industry.
“Demand for ever more powerful semiconductors could increase dramatically in the years ahead as companies outside the technology industry invest in customised large language models for their own use,” he says. “Technology companies will also drive semiconductor demand as they accelerate investments in AI.”
Several other sectors will benefit from the current backdrop, according to Franklin Templeton. China is a world leader in manufacturing solar energy storage systems (ESS) supply chain products, potentially a key export driver. It is forecast to install almost half of new global renewable power capacity between 2022 and 2027, as growth accelerates in the next five years, despite phaseout of wind and solar photovoltaic (PV) subsidies.
HSBC expects Beijing to roll out more fiscal and monetary easing measures. Image via Bloomberg
“While the global supply chain of manufacturing is diversifying, we believe China will continue to have a dominant role,” affirms Mr Sehgal, citing premier Li Qiang’s reassurance of markets about government support for advanced manufacturing and technology to attract foreign investment. As a major centre for development of electric batteries, he expects China to lead the way for deployment of electric vehicles.
At home, the expansion of middle class buying patterns as the economy re-opens promises a long-term “structural tailwind”, with $2.6tn in Chinese bank deposits amassed in 2022, according to the People’s Bank of China. “Middle-class households are looking to draw down these saving to spend on experiences, products and services,” he predicts, while warning of the challenges presented by a declining and ageing population and a peaking real estate sector, a previous growth driver.
Pan-Asian impact
Abroad, China is diversifying its trade with more “neutral countries” in the Asean and Latin American regions, supporting further growth. The impact which recovery will have on other Asian economies is particularly important to analysts at HSBC, one of the region’s wealth management powerhouses.
“China’s stronger-than-expected consumption-led recovery offers an important anchor for the Asian economies to weather headwinds from the financial tightening and weakened external demand in the developed economies,” believes Fan Cheuk Wan, chief investment officer, Asia, global private banking and wealth at HSBC, speaking at the bank’s iconic headquarters built by architect Norman Foster. “Cyclical turnaround in China demand, resilient Indian and Asean growth should help mitigate the drag from the global downturn,” she says.
Upward earnings momentum across Asia has been driven by upgrades for China’s consumer, internet, banking and healthcare sectors and Indonesian banks and telecoms. In contrast with the US downtrend, China’s earnings cycle bottomed out at the end of 2022 and returned to a strong upturn, according to HSBC.
Market consensus is now looking for 24 per cent 2023 earnings per share growth for Chinese equities, representing a sharp turnaround from the -17 per cent earnings recession in 2022. “Riding on the tailwinds of China’s cyclical upturn and the overall growth acceleration of the Asian economies, we stay fully overweight on mainland China and emerging Asia equities and are mildly overweight on Hong Kong, Indonesia and Thailand stocks,” reveals Ms Fan.
But China’s recovery path remains uneven, she warns, with lower than expected industrial production in March, coupled with substantial decline in property investment and cautious business sentiment, combined with weakened global demand, hampering investment into manufacturing and infrastructure.
HSBC’s Ms Fan expects Beijing to roll out more fiscal and monetary easing measures to sustain recovery momentum, boosting domestic demand: “This should support our positive view on China and Asian equity markets versus the developed markets, which will be hit by credit tightening in wake of the banking sector turmoil.”
