In this exclusive article, Fidelity International explores initial China recovery expectations, a K-shaped recovery, inflation outlook, market pricing and why Fidelity are finding plenty of companies with a strong pathway of growth, trading at attractive valuations.
Expectations were high for the reopening of China: the hope had been that it would galvanise not only growth across Asia but also provide a shot in the arm for the flagging global economy. Leading the economic fightback would be the Chinese consumer, unleashing savings banked during the pandemic lockdowns.
Six months on, it is clear that many of these expectations were overblown: the recovery has been tepid. While services data has been relatively strong, demand for goods has remained mixed, with luxury and lower priced goods seeing some signs of recovery but mid-tier priced products struggling. Chinese unemployment levels have remained relatively high, which could explain some of this tempered consumer spending[1]. The lagging property sector may also be a factor.
This has led some to the gloomy conclusion that the Chinese recovery is already over. Being based in China, the Fidelity team has formed a difference impression. While there is definitely a confidence problem for the Chinese consumer, they still have an unspent war chest of savings, they are still getting richer, and there is still likely to be improvement ahead. However, the recovery will not be evenly spread and investors will need to be careful on the winners and losers.
Early days
Initial expectations of the recovery were almost certainly too high and the recent data is simply part of a bumpy return to normality for the Chinese economy. The profound impact of the zero-Covid policy for China’s citizens cannot be underestimated and it will take time to emerge fully from the dislocations it created.
There remains relatively low confidence among Chinese consumers and little propensity to spend. Confidence plunged during the final months of the zero-Covid policy and while it has bounced higher, it remains very low on historic trends[2]. We don’t believe this is permanent, but recovery will take time and some patience in needed.
The same is true for the corporate sector. Management teams have been through a significant shock and it will take time for capital expenditure to revive. When it does, it should boost the labour market and start to raise confidence, but again, this will not happen over the space of a few months.
Nevertheless, there are encouraging signs in both the corporate and consumer segments. For Chinese companies, lower expenditure is being felt in improved corporate cash flows. We also see cost rationalisation and efficiency measures improving corporate earnings. Chinese companies are increasingly using artificial intelligence to offset cost pressures, while consolidation is also a feature across many industries.
K-shaped recovery
In reality, the recovery is likely to be more ‘k-shaped’. This is where the performance of different parts of the economy diverges like the arms of the letter K. Some sectors look set to do well, while others will continue to lag. This is informing our approach to the Chinese markets.
For example, Chinese consumers are more interested in services over goods. This is understandable. Having been confined to their homes for two years, many want to eat out, or travel, rather than buy more things. This has led us to focus more on areas such as tourism in the Fidelity China Special Situations portfolio.
Where we have exposure to spending on goods, it is in areas where demand has been extremely resilient. We have seen strong demand for jewellery, for example, with many buyers seeing it as a store of value in uncertain times. We hold a retail jewellery group in the portfolio that is currently seeing strong market share gains. Demand for certain branded consumer goods, such as Coca-Cola has also been resilient, with demand holding up even through the pandemic. We have a Coke bottler in the portfolio.
The headline data does not tell the whole story. In reality, the Chinese consumer segment is complicated. It is a large and populous country, with significant divergence between regions. The successful consumer companies are those that can find pockets of demand as consumer spending revives and provide value to them.
Inflation outlook
There are broader reasons to be positive on the Chinese economy. Inflationary pressures remain limited. Consumers appear to be increasingly price conscious, which is impacting some mid-tier products and services. Competition is increasing everywhere – in ecommerce, electric vehicles, or energy storage for example. Even with some labour cost inflation, these factors are acting as disinflationary forces, keeping costs low for consumers.
The lack of inflationary pressure also gives the central bank plenty of flexibility to ease monetary policy should domestic demand remain weak. This could be in the form of local, bottom-up government support or more central government spending. Either would help revive confidence in the consumer and corporate sectors and support the recovery.
Market pricing
In the meantime, investor confidence remains weak. After an initial bounce, share prices have dipped again since April. Many of China’s flagship consumer and internet companies have been significantly derated. The major ecommerce platforms are now on single digit price to earnings multiples, compared to 30-40x for their US peers[1]. This means a lot of bad news is reflected in market pricing.
While some commentators have characterised this as a ‘value trap’, this is not our view. Certainly, there are areas of distress, where valuations can continue to get worse. However, we are finding plenty of companies with a strong pathway of growth, trading at attractive valuations in this environment. Any stock market is a combination of individual companies. Individual companies are driven by idiosyncratic factors that may have little to do with the growth in the Chinese economy. China is home to a range of significant structural growth stories, including renewable energy, battery power and a rising middle class. These remain intact no matter what the pace of recovery.
No single policy is likely to bring about a dramatic change in sentiment towards China. Equally, for the naturally bearish, there are always potential problems for Chinese markets – from youth employment to ongoing problems in the property sector. However, the recovery isn’t over. Far from it, it is just getting started.
Fidelity China Special Situations PLC (LON:FCSS), the UK’s largest China Investment Trust, capitalises on Fidelity’s extensive, locally-based analyst team to find attractive opportunities in a market too big to ignore.
Important Information:
The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments are subject to currency fluctuations. Fidelity China Special Situations PLC can use financial derivative instruments for investment purposes, which may expose it to a higher degree of risk and can cause investments to experience larger than average price fluctuations. This trust invests more heavily than others in smaller companies, which can carry a higher risk because their share prices may be more volatile than those of larger companies and the securities are often less liquid. This Investment Trust invests in emerging markets which can be more volatile than other more developed markets. The shares in the investment trust are listed on the London Stock Exchange and their price is affected by supply and demand. The investment trust can gain additional exposure to the market, known as gearing, potentially increasing volatility. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser. The latest annual reports, key information document (KID) and factsheets can be obtained from our website at www.fidelity.co.uk/its or by calling 0800 41 41 10. The full prospectus may also be obtained from Fidelity. The Alternative Investment Fund Manager (AIFM) of Fidelity Investment Trusts is FIL Investment Services (UK) Limited. Issued by Financial Administration Services Limited, authorised and regulated by the Financial Conduct Authority. Fidelity, Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited.
[1] https://www.cnbc.com/2023/05/30/chinas-disappointing-rebound-could-bring-in-more-stimulus-economists-say.html
[2] https://tradingeconomics.com/china/consumer-confidence
[3] https://www.macrotrends.net/stocks/charts/META/meta-platforms/pe-ratio#:~:text=The%20PE%20ratio%20is%20a,information%20on%20our%20historical%20prices.
