Fidelity China Special Situations (FCSS ) fund manager Dale Nicholls is tilting towards consumer stocks and beaten-up property companies to tap into the country’s short-term reopening recovery and its longer-term objective to increase consumer spending.

Nicholls, who has run the £1.4bn China trust for nearly nine years, had plenty of stocks with wilted valuations to choose from in 2022 as successive Covid-19 lockdowns put China’s stock markets and economy under pressure.

By the end of the year, Nicholls said it was ‘hard to get worse and hard to get cheaper’ in Chinese equities as Covid-19 policy was ‘a huge constraint on economic growth’.

But a government U-turn in response to widespread protests has led to a surprisingly rapid stock market rebound, with the trust’s shares up 44% in the past three months.

They have rallied 21% since the start of the year, narrowing their discount to net asset value to 5%, having seen the gap widen to as much as 15% in the 2022 crash. All this has maintained the trust’s long-term record as one of the best-performing emerging markets closed-end funds, with a total shareholder return of 254% over 10 years. That beats the MSCI China index, which has returned just 75%.

Fast and furious

‘I was expecting change in China but not this early and not this fast,’ Nicholls said last week. ‘China has got cashed-up consumers that have been locked up for a couple of years and the outlook is good and the sentiment is good.’

The ¥‎30tn (£3.6tn) built up over three years of lockdowns will be a major driver of economic growth and stock market returns, with Nicholls stating that the region will ‘be one of the few large economies with accelerated growth and earnings growth this year’.

While the Chinese government did not provide the same level of stimulus to its economy during the pandemic that many Western governments did to theirs, Nicholls said ‘household balance sheets are very strong’ and the spending spree could be ‘significant’ this year.

While consumer stocks have always been ‘core’ to Fidelity China, Nicholls said one of the biggest changes he had made over the past 12 months was to lean further into the sector as ‘stocks sold off and we got a chance to build our positions’, with consumer discretionary now the biggest sector exposure at 35.7%.

He flagged retailer Miniso Group and jewellery retailer Luk Fook as companies that can offer ‘substantial growth opportunities’.

Property supported

One consumer-focused area that Nicholls (pictured above) is excited by is property, which suffered a brutal downturn when debt-laden developer Evergrande Group teetered on the brink of collapse.

Nicholls said it was a ‘changing sector’ due to another policy U-turn. While politicians and policymakers have previously tried to constrain the sector over ‘concerns about high prices and affordability’, this tight regulation is giving way to ‘supportive regulation’ and billions of dollars worth of fiscal support.

The manager said this stimulus should ‘continue to drive down mortgage rates’ and ‘support the sector’, noting that the sale of second homes was already recovering.

‘There is a good chance property has bottomed,’ he said. ‘We increased our exposure to property as the stocks came off, but we have a select focus on state-owned developers that we think are in a strong position and will come out stronger than private developers.’

Nicholls said there are ‘a lot of [property] stocks that have got really cheap’, including China Overseas Grand Oceans, which he said develops properties in ‘lower-tier cities and has a strong, established position in the market’.

‘It did sell off but… is now in a strong position,’ he said, adding that the company’s focus on lower-tier cities with populations of over one million weighed on its valuation as investors were ‘more negative on that part of the market’.

‘There is demand in that area and we are talking about a very cheap stock that is trading on a single-digit price/earnings,’ he said.

Alibaba and technology

Another troubled sector set to benefit from the revival in consumer spending is technology, which Nicholls said found itself in the ‘eye of the regulatory storm’ last year but clarity was slowly appearing.

‘Tech stocks did get extremely cheap. Platforms like Alibaba, which is a market leader, got to single-digit multiples. And for that kind of business, it is extremely cheap.’

Unlike rivals Baillie Gifford, which sold out of Alibaba last year, fearing its future growth rate would deteriorate, Nicholls has maintained an index weighting of 8% in the giant e-commerce platform.

He said tech stocks were ‘not the bargains they were in November and December’ but offer ‘decent valuations’, especially in e-commerce, which he believes will be a reopening play.

Increasing exposure to consumer spending is not just a reopening play. Nicholls believes it is a long-term story as the government moves the economy away from exports to domestic consumption to provide ‘better quality, stable growth’.

As a result, he said China would be one of the ‘few economies that accelerated and accelerates earnings growth’ this year as the ‘development of the middle class’ in China ensures ‘rising penetration’ of consumer brands and ‘increased premiumisation’.

‘The long-term drivers for the consumer are there, and the natural development of the middle class as a trend is unstoppable,’ he said.