Chinese dragon looks ready to fly again

Szu Fuei Chong, Manager of our Far East Growth Fund, explains why she has actively increased her exposure to China, where the government may be poised to introduce new stimulus measures to accelerate growth.

We believe the outlook for economic recovery in China is looking increasingly positive. Economic growth had faltered because of restrictions imposed under Beijing’s zero-COVID policy. However, the latest data from Chinese purchasing managers’ indices indicates growth may now have stabilised, ready to move into a more positive upward trend.

Nonetheless, a comprehensive fiscal stimulus programme will be required if the country is to achieve the government’s target growth rate of around 5.5% for the year as a whole. Beijing had seemed reticent about taking such measures. However, high levels of youth unemployment and the prospect of elections in October mean President Xi Jinping may find it difficult to resist growing pressure for action. He will also be keen to avoid the potential loss of prestige if China reports a lower growth rate than the US.

We are already seeing more positive news flow and encouraging policy announcements, for example financial institutions being encouraged to support local government infrastructure projects. It should be remembered that China has a far lower inflation rate than many developed nations and significantly greater scope to introduce monetary easing measures – at a time when other countries are tightening.

At the same time, valuations on Chinese equities look attractive and we are starting to see strong inflows into the country’s equity market.

Against this backdrop, we have substantially increased our exposure to China by identifying opportunities to add to existing Chinese holdings in the fund at attractive valuations. During June we increased our exposure to Chinese equities by over 10%, bringing the allocation to around 35% of the portfolio, which is close to the benchmark level.

“An improving economic picture in China will have a broader effect, potentially providing a tailwind for other nations in Asia.”

We have added to our holding in Chinese technology giant Alibaba, which now accounts for around 5% of the portfolio. This is a value play, with Alibaba on a price-to-earnings multiple of only 14x, when many other internet players are on more than 20x. The company is also likely to benefit from an improving macroeconomic backdrop in China and we see potential for earnings forecasts to be revised upward. Losses from the ecommerce division are narrowing and the news flow around the planned IPO of fintech business Ant Group, an Alibaba affiliate company, looks increasingly positive.

We have also added to our position in China Merchants Bank, which sold-off in April after China’s top anti-corruption watchdog announced it was investigating the company’s former president. We believe CMB has been oversold. The allegations are against an individual, not the company, which is one of the best private sector banks in China, with an above-average return on equity and strong earnings. The bank has appointed a new president, who may bring improvements to the business, and we believe this could be a catalyst for share price appreciation.

In addition, we have increased our investments in two companies benefiting from the global shift to greener energy. Yunnan Energy New Material Company is a leading supplier of separator film used in lithium-ion batteries in electric vehicles. Yunnan has a strong market position, achieves high margins and is in a growth sector. The other company is Xinjiang Goldwind, which is a leading global wind turbine manufacturer. This is a strong business benefiting from the powerful increase in worldwide demand for renewable energy.

Widening the focus, we believe that an improving economic picture in China will have a broader effect. If Chinese economic growth regains momentum then this will provide a tailwind for many other nations in Asia, creating a particularly attractive opportunity for investors when Western economies face significant challenges.

Szu Fuei Chong 20/07/22  

Source: BEA Union Investment Management Limited, Union Investment, June/July 2022

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