Investing in China has been a rollercoaster ride over the past five years. Despite a period of outperformance as all of the world’s economies struggled with the pandemic in 2020, during the two years either side of that time Chinese market returns have been much more modest.

During 2021 we exited our passive Chinese equity investments in favour of broader Emerging Markets positions. At that time, China’s prolonged zero-COVID approach and the emergence of ‘Common Prosperity’ as a policy prescription were both working against the country’s economic prospects. As a result China’s equity indexes underperformed in 2022.

In Q4 2022 we started to rebuild positions.

Why?

• Valuations were very depressed and so attractive, especially compared to developed markets
• China is at a much more favourable stage of the cycle for equities than developed markets. The economy is weak but recovering and policy is easing, whereas in developed markets it is tightening
• However, the zero-COVID policy was depressing economic activity which prevented these policy measures from flowing through to the real economy
• The reopening changes this. Our initial expectation was that the market would price the reopening quickly. But the pace of the withdrawal of zero-COVID has accelerated quicker than anticipated. With potential herd immunity in Q1, Q2 onwards will show an acceleration in growth as pent-up demand comes through.

In the very near term, the path could still be bumpy many long-term issues need to be addressed. Structural headwinds that could hamper the performance of China’s economy will remain.

Considerations

• Policymakers are focusing on consumption-driven growth, rather than the infrastructure-driven growth of old. Index and sector selection is therefore key in this environment
• We see the domestic property sector stabilising after this period of deleveraging. However, it will not drive growth like in the past
• As the economy shifts towards services from goods production, China’s trend growth rate will slow
• There is still likely to be a risk premium associated with Chinese markets as investors assess the medium to long term intent of Xi’s vision for China

Overall, we think that China represents a short-term opportunity and we consider our positions to be tactical in nature.

Our approach to reducing and then rebuilding exposure in this market is an example of how Cardano’s portfolio management processes work in practice. Our team of investment professionals constantly monitor global markets to identify opportunities and dynamically adjust risk allocations. Whilst we remain cautiously allocated to equities on a global basis, we will seek out opportunities where we see value. China became one of those opportunities late last year and can remain so whilst the country’s post-COVID economic recovery persists.

As is customary in the year of the Rabbit, we wish you longevity, peace, and prosperity – Happy Lunar New Year!