US and China - “Volatility is not always a bad thing”

Despite recent market volatility, China has been performing well in 2020. The Chinese economy returned to growth and the CSI 300 has generated a strong return over the year to date, significantly ahead of the S&P 500. Could China’s strong performance continue and what impact is the political fallout with the US having on investment opportunities in the region?

The US-China contest could have “positive effects”

Ian Hargreaves, Co-Head of Asia and Emerging Market Equities and Manager of the Invesco Asia Trust, said: “The relationship between the US and China is likely to remain tense for the foreseeable future. While we need to consider the potential impact of trends such as deglobalisation, we seek to ensure that companies’ supply-chains are less reliant on China.

“We are also cognisant of the fact that the contest between these two superpowers may have positive effects on growth, innovation and productivity. For example, with both sides determined not to give up an opportunity to take a lead in science and technology R&D, there is likely to be even greater levels of government investment in these areas. Innovative Asian companies stand to benefit, and these are well represented in the portfolio at present where valuations permit, but we also remain alert to undervalued opportunities in more cyclical areas where expectations are less demanding.”

Mike Kerley, Fund Manager of Henderson Far East Income, said: “The threat of restricting Chinese companies from US products is driving China to focus on self-sufficiency. This is an investable theme although valuations are getting a bit rich for the obvious beneficiaries.”

Dale Nicholls, Portfolio Manager of Fidelity China Special Situations, said: “The US-Sino trade dispute is likely to continue as we get closer to the US election in November, which could have a knock-on impact for the Chinese economy and equity story. That said, geopolitical tensions will not distract me from my ongoing pursuit of investing in long-term capital growth via investments in well-managed companies in sectors such as consumer, technology and pharmaceuticals which will benefit from structural change in the domestic Chinese economy.  Additionally, I believe that volatility is not always a bad thing. It can create opportunities to invest in high-quality companies at attractive valuations and I see the current environment as certainly one of those times.”

What’s behind China’s strong performance?

Rebecca Jiang, Co-Manager of JPMorgan China Growth & Income, said: “With shops and factories running at close to full capacity, domestic supply is gradually coming back online. Over time, we believe the growing Chinese middle class will continue to upgrade what it consumes, and in the longer term consumption trends in mainland China will continue to remain strong. That said, the long-term attractions of A-shares also remain intact. The A-shares market now has more than 3,000 listed companies, including a growing number of mainland companies that are able to cater to evolving domestic tastes.”

Mike Kerley, Fund Manager of Henderson Far East Income, said: “Chinese markets have been buoyed by a recovering economy, excess liquidity, government support and a distinct lack of investment alternatives. The rally has been narrow, though, with the new economy leading the old economy by some considerable margin. With valuations getting elevated in these areas the rally needs to broaden to be sustained.”

Ian Hargreaves, Co-Head of Asia and Emerging Market Equities and Manager of the Invesco Asia Trust, said: “Chinese equity markets appear to have enjoyed a period of strength, supported by a favourable mix of improving economic activity, undemanding valuations compared to history for the domestic market, local enthusiasm thanks to an element of policy support or verbal encouragement and good liquidity. There’s also been a sense that the coronavirus threat has been well managed, with confidence that future outbreaks can be contained. 

“As to whether this can continue? We believe that both valuations and future earnings trends look supportive. While valuations are less attractive than they were, they are not stretched for the broader market. We expect economic policy to remain supportive and this should aid a recovery in earnings from the Covid19-driven downturn as we look ahead into 2021.”

Opportunities in healthcare and technology

Rebecca Jiang, Co-Manager of JPMorgan China Growth & Income, said: “Our bottom-up stock selection reflects key long-term structural growth opportunities and we are finding them in healthcare and technology sectors. Healthcare is a broad term in the Chinese context and there are opportunities in innovative pharmaceuticals making returns from R&D investments and services and distribution companies. Within the technology space there will of course be winners and losers, but the ongoing pandemic has accelerated demands for higher internet penetration and improved remote working capabilities. Our conviction in the attraction of these areas remains undiminished. One example of a company tapping into this area of growth in technology is Beijing Kingsoft, which is a dominant domestic office software provider, riding on market share gains and user numbers.”

Dale Nicholls, Portfolio Manager of Fidelity China Special Situations, said: “I continue to have a core focus on consumer and technology-related companies, which I expect to benefit from the domestic Chinese structural growth drivers; in fact, the portfolio is almost exclusively focused on the domestic Chinese economy, with 98% of revenues currently derived from Greater China (China, Hong Kong and Taiwan).

“Price decreases seen since the outbreak of the virus have created many opportunities to purchase well-managed companies that I’ve previously considered attractive but too expensive. One example has been the initiation of a position in aircraft lessor BOC Aviation, as I expect it will weather the downturn better than peers. In previous downturns, while some airlines have struggled and failed, airline lessors have benefited by re-leasing aircraft to stronger survivors. I believe that although this position is based on a somewhat contrarian view given the outlook for much of the aviation sector, current conditions should provide an opportunity for BOC to use its balance sheet strength to grow its leasing book.”

Ian Hargreaves, Co-Head of Asia and Emerging Market Equities and Manager of the Invesco Asia Trust, said: “The Invesco Asia Trust has significant exposure to China, although limited exposure to banks and real estate companies means we are and have historically been underweight relative to regional indices. The opportunities we like most are consumer-related names, with internet companies such as online gaming developer NetEase and e-commerce player JD.com having been very good long-term investments for us.”

Mike Kerley, Fund Manager of Henderson Far East Income, said: “In China we like domestic orientated areas with valuation support. Property has appeal due to continued government support, for example China Overseas Land, as does construction and materials, such as China Rail Construction and China Resources Cement. Value in the consumer sector is more difficult to find but we like Hengan in the tissues, diapers and sanitary ware space. We’ve also had exposure to Macau casinos for some time, and we continue to think these could be interesting when visa restrictions are lifted.”

China’s long-term outlook

Dale Nicholls, Portfolio Manager of Fidelity China Special Situations, said: “One of the strongest drivers of Chinese growth in coming years continues to be the consumption story and the natural growth and development of China’s middle class. Another area of growth that will support the portfolio over time is the increasingly significant role China will assume in global equity and bond markets over the next decade. China’s share of the MSCI AC World Index has risen from 1.9% to 4.9% over the past ten years and I expect its share to continue to rise. As this trend plays out, China will be increasingly difficult for global investors to ignore.

“The sheer breadth and depth of China’s onshore markets and the lack of institutional investors means that stocks are relatively under-researched and provide rich stock-picking opportunities for active investors. Importantly, this shift is underpinned by China opening up its capital markets to foreigners – for example, market access for international investors has improved over the years via the launch of the Hong Kong–Shanghai Stock Connect programme in late 2014 and the extension of the Hong Kong–Shenzhen Stock Connect.”

Rebecca Jiang, Co-Manager of JPMorgan China Growth & Income, said: “Despite short-term uncertainties, the long-term case for investing in China remains intact. We believe the long-term structural story in China will continue to be driven by healthcare, technology and the consumer. Many of the growth opportunities as well as the wider development of the market continue on the same track. Ongoing improvements in the Chinese technological infrastructure are a case in point. The development of the Chinese 5G network, for example, will help companies improve efficiency and expand margins. Conversely, improved connectivity will provide a better platform for gaming and online shopping for consumers, especially in a country with hundreds of millions of millennials keen to spend.”

Mike Kerley, Fund Manager of Henderson Far East Income, said: “Whilst the outlook for the second half of 2020 is still unclear, if most sectors continue their trend of improvement then China is on course to achieve growth in GDP in 2020 and will be one of the very few countries to achieve this. Over the long term, we are positive on the outlook for China. The government has handled the monetary and fiscal response well and the economy is on the right foot. Politics and relationships with the West are a risk but Beijing has quite a lot of flexibility to adjust policy accordingly. The market has some interesting companies, but price movements are unpredictable and dominated by momentum and speculation, so it is important to be selective on stocks and entry points.”

-Ends-

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