The spectacular reversal of Chinese stocks, risk or opportunity?

The spectacular reversal of Chinese stocks, risk or opportunity?
The spectacular reversal of Chinese stocks, risk or opportunity?

We favor an intermediate path which consists of exposure to the equities of emerging Asian countries, including China.

After three catastrophic years for Chinese stocks, the market is regaining color at the start of 2024. Performance, however, depends on the index used: onshore vs. onshore. offshore, large caps vs small caps etc… From the point of view of the international investor, the MSCI China remains the benchmark. Between the end of 2020 and the end of 2023 this index fell by 45%, due to the downturn in the Chinese real estate market and the risks that this poses for growth and the banks’ balance sheets. Also, trade wars and poor management of the pandemic have been a signal of indiscriminate selling for international investors due to the lack of visibility. As for onshore indices, they were less disrupted, particularly small caps, with the CSI 300 and CSI 500 having fallen by 30% and 10%, respectively, during the same period.

But suddenly, since the end of January, the Chinese “offshore” indices have started to rise again, with the MSCI China posting a staggering performance of +23%, vs. 7% for MSCI World. This calls for a strategic review for global investors who have abandoned China.

China will not embark on the conquest of Taiwanese territory in the medium term. The price to pay for economic isolation would be too high.

On a fundamental level, nothing has really changed. Economic activity is relatively moribund, although improving according to the PMI indices, and household consumption is a drag on growth. External demand is the driving force of activity, but it is vulnerable to the risk of trade sanctions, particularly in an election year in the United States. Europe is not left out, since Chinese exports of electric vehicles are the subject of an investigation by the European Commission for unfair trade practices, while China is looking into imports of European spirits. Visibility is therefore always low and can disappear quickly.

How to position ourselves in the face of this rebound in the Chinese market? On the one hand, offshore Chinese stocks are still attractively valued and the value generation potential associated with this discount is substantial. But obviously, this valuation discount is not free. It reflects uncertainties about governance, the growth model, trade tensions, geopolitical tensions, etc. The market should remain sensitive to polls on the American elections, Donald Trump having announced an aggressive increase in customs tariffs against the China if he was elected. The Chinese stock market should therefore remain volatile and vulnerable to these exogenous shocks.

On the other hand, it seems to us that this Source of risk is manageable, as long as it is well diversified. China will not embark on the conquest of Taiwanese territory in the medium term. The price to pay for economic isolation would be too high since Chinese growth relies on exports. A collapse in growth could in turn call into question the sustainability of the political regime and the Communist Party. To position yourself for opportunities while managing financial risk, we continue to recommend exposure to emerging Asian equities, which involves exposure to China diluted with other markets in the region such as South Korea, Taiwan, and India. South Korea and Taiwan have a marked Tech bias, which in a way amounts to positioning themselves on Samsung and TSMC, alternatives or portfolio complements to Apple and Nvidia in the United States with a valuation discount.

India is a market that is not easy to access but whose economic growth will remain very strong over the coming years, as the standard of living converges towards that of more industrialized countries. The re-election of Narendra Modi should further strengthen confidence in the potential for reforms and growth. The region is therefore a reservoir of growth, in some cases with a valuation discount as in China, which is moving upmarket in many sectors, such as technology and the energy transition.

From the investor’s point of view, there is no performance without risk and the question is whether the China risk is acceptable. It seems to us that yes, but in moderate proportions, which reflect the many potential hazards linked to China’s rivalry with the West. This exposure must therefore be the subject of particular attention and dynamic risk management in order to be able to quickly adjust sensitivity in the event of headwinds. A regional approach brings a significant gain in diversification.

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