Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

INVESTORS in China will hope that today’s New Year can bring the difficulties of 2021 to an end.

Last year’s sudden wave of regulations saw Chinese stocks, which have enjoyed a near impregnable rise in recent decades, come crashing down to earth. With the exception of Latin America, China was the worst-performing major equity market across the globe last year.

The trigger for the collapse was a shift in stance from the Chinese Communist Party (CCP) that now puts ‘common prosperity’ at the fore. Regulators homed in on sectors like technology, education and gaming. The country’s Big Tech firms, such as Alibaba and Tencent, slumped, while the collapse of over-indebted property group, Evergrande, threatened to bring down the rest of the market with it.

It all caught investors on the hop, prompting some to question whether the risks of unexpected policy changes in China now undermine its long-term structural growth story.

In reality, there’s little reason to think these measures dealt China’s growth a lethal blow. The consequences were stark, but it’s worth remembering that the West turned up its own regulatory dial last year.

The difference was that China’s efforts were more successful. Its one-party state reigned companies in far more quickly than the US and Europe could ever hope to. Catching investors off guard, a swift correction was inevitable.

It’s possible we’ve already seen the worst of the damage. Goldman Sachs recently described 2021 as the “announcement” phase of the country’s new regulatory regime. A subsequent “implementation” phase this year could mean improved policy transparency, and fewer market wobbles. The CCP’s stance is also likely to soften in the run up to its 20th Party Congress in November - historically, equities have performed well ahead of the event.

Dale Nicholls, manager of the Fidelity China Special Situations investment trust, thinks the worst is behind us. He says: “While there is still risk of new regulation, there is a good chance that we are near or close to a “peak” in terms of news flow”.

In the meantime, tumbling stock prices now lend China a compelling valuation argument. According to Nicholls, “valuations for many companies have moved to historical lows and look even more compelling when we compare them to global peers”.1 China’s discount to global equities is near an all-time high, while corporate earnings are forecast to grow over 15% for the next 12 months.

Crucially, many of those broader themes that have made China so attractive remain intact. The country is still scheduled to become the world’s largest economy over the next decade, while thriving consumer and green energy sectors retain government support.

Meanwhile, a new monetary backdrop offers encouragement. ‘First in, first out’ of the pandemic, China is at a different stage in its cycle from western governments, meaning it has more room to encourage growth than the US or Europe. Recent cuts to borrowing rates could endear foreign investors whose oven governments are now beginning to tighten.

Those are the positives. There remain some serious negatives.

The first is the ongoing impact of Covid and the country’s ‘zero-Covid’ policy. It doesn’t take much to close a Chinese city these days. The 1.2 million residents of Yuzhou were told to stay inside earlier this month after just a handful of asymptomatic cases were discovered.

Restrictions of this severity will have a marked effect on consumption. Consensus forecasts see China’s economy expanding by 5.5% over 2022, a slump on the 8.1% recorded last year (which admittedly started from a lower base), and a serious lag on the past four decades’ average 10% annual growth. It’s no coincidence the country has started tightening just as the Omicron variant threatens to derail its recovery.

The property market, meanwhile, remains a thorny issue. On the plus side are rising interest rates (which will feed into mortgage rates) and the likelihood that policymakers will soften their stance. On the negative is its sheer weight on the economy. Property comprises around 15-20% of the country’s Gross Domestic Product (GDP). A household’s property costs alone can swallow 70% of disposable income, more than three times the average in developed countries.

The market’s significant crossover with the wider economy means that any permanent reduction in size is likely to diminish overall economic output.

Then there’s the geopolitical situation. It’s hard to know exactly what this will amount to (US-China trade frictions are a perennial concern, for instance), but disputes on the international stage threaten to catch investors off guard.

Where does all this leave investors now? Confused, probably.

Predicting how markets behave is never simple; with China, it’s near impossible. At the end, you’re left with a long list of ‘known unknowns’ that makes investing in China riskier than most developed economies.

Nevertheless, its broader growth story is hard to overlook. Given it’s cheaper to buy into at the moment than ever, it’s not hard to see how Chinese stocks could surge this year. Now, as the year of the tiger pounces on 2021’s ox, investors may look to grab the bull by the horns.

For more on the prospects for Asia and Emerging Markets, watch Fidelity Investment Director Tom Stevenson’s latest outlook:

1 The MSCI China Index is now trading at a forward price to earnings (P/E) ratio of 12.1, with the global benchmark trading at 19.5 times earnings.; MSCI China Index; MSCI World Index. As at 31 Dec 2021

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. The shares in Fidelity China Special Situations investment trust are listed on the London Stock Exchange and their price is affected by supply and demand. The investment trust can gain additional exposure to the market, known as gearing, potentially increasing volatility. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.

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