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 were understandably optimistic about China after the end of its Zero Covid policy in January. Since then, the country has not gained the momentum investors had hoped for.

China is in the news for three reasons.

First, the Chinese stock market has underperformed. Secondly, this underperformance reflects a perception that China has considerable economic challenges. And thirdly, there’s disappointment that the bounce back from Covid has not materialised.

Chinese retail sales increased by just 2.5% in July, slowing from 3.1% in the previous month. It fell short of a forecast 4.5% rise.

Although industrial production was up by 3.7%, it was lower than the prior month’s 4.4% rise. It fell below a forecast 4.4% increase.

And China’s consumer prices fell in the year to July by 0.3%. “The trends in the data are not heading the right way and as expected,” said Tom Stevenson, Investment Director. “It keeps giving investors reasons to pause for thought.”

What’s going on with China’s economy?

Economic growth is slower than people had hoped and it is increasingly being reflected in forecasts.

Following China’s latest interest rate announcement, economists at Citigroup downgraded their annual growth forecast to 4.7%1 while UBS lowered their forecast to 4.8%. Both fall short of Beijing’s official target of about 5%.

One of the key drivers of the Chinese economy is the property market.

“The property market is weak,” Tom said. “There’s too much supply and house prices are falling. Meanwhile, big companies like Evergrande and Country Garden have either defaulted or are at risk of defaulting on loans.”

He said that China’s likely to be in deflation.

Youth unemployment is also a growing issue. The most recently published data for June showed that the level of unemployment among young people has risen steadily to over 20% and the data is no longer being published.

What action is being taken?

China’s central bank is cutting its interest rates in a bid to spur growth.

Still, the People’s Bank of China is in a bit of a dilemma. “Although they want to cut interest rates, they don’t want to reduce the profitability of banks. They want to avoid this problem. Like many central banks, it is caught between a rock and hard place.”  

What has been the impact on investments and markets?

None

Source: Refinitiv, total returns in local currency from 22.8.22 to 22.8.23, rebased to 100. Past performance is not a reliable indicator of future returns.

The chart tells the story of China’s divergence from broad global financial fortunes. While the MSCI World index has powered ahead from March onwards, rising by more than 6% over the past six months, China’s CSI 300 index has fallen by more than 8%. Since the beginning of last year, the global index has fallen by 10% but China’s benchmark is 25% lower. This has an obvious and painful impact on funds that invest only in China. Year to date, all 39 funds in the Investment Association China/Greater China category have lost investors money, ranging from the 7.7% decline for the Fidelity China Focus Fund to a 22.9% fall for the abrdn China A Share Equity Fund.

It also has an impact on some emerging markets funds that are particularly exposed to China. For example, the iShares Core Emerging Markets ETF on the Select 50, which holds four Chinese stocks in its top ten investments, has only risen by 3.9% year-to-date.

There may be less obvious impacts for your portfolio.

Some companies are particularly exposed to the country’s financial health.

The slowdown in the property sector is having an impact on commodity groups, for example.

Recently, BHP, the world’s biggest miner by market capitalisation, reported its lowest annual profit in three years2.

The company, which is listed in Australia, highlighted the property issues in China and was concerned about the severity of any steel production cuts by Beijing. 

It can also impact UK companies. Cambridge-based chipmaker Arm has faced questions over its exposure to China in the run up to its planned list on the New York Stock Exchange.

Arm’s IPO filing showed that it made a quarter of its revenue from China and warned that it was “particularly susceptible” to economic and political risks.

Fund managers said that there were also fears about the global semiconductor industry, amid souring relations between Washington and Beijing3.

How cheap is China’s stock market after the recent falls?

Martyn Dropkin, Head of Equities, Asia Pacific, said that Chinese stocks offer appealing value compared to history and other markets in Asia.

The 1-year forward price-to-earnings (PE) ratio for MSCI China is 10 times versus its 10-year average of 11.4 times. It’s close to the largest discount to the rest of Asia for the past 20 years.

However, caution is warranted.

Martyn said that although metrics reveal market valuation and earnings trends, they overlook the dynamics within the Chinese stock market. He said that this diversity highlights the value of active bottom-up investment strategies.  

Is the long-term China story still valid?

Although China’s demographic problems have some similarities to Japan and South Korea, it doesn’t discount the fact that the country remains a huge economy.

Although geopolitical concerns will remain on the radar of investors, Tom said that China still has good long-term growth potential.

There are pockets of optimism investors can look forward to. Certain sectors and companies are proving resilient.

Pent-up demand remains among consumers. Trends like experience-based spending, health consciousness and premiumisation continues to grow.

There are signs of recovery in high-end luxury goods. Financials, particularly insurance are also benefiting.

China has an impressive pace of innovation too. Automation opportunities driven by an aging population and the energy transition continues to create interesting investment opportunities. Many of these are part of core industries that are important to the Chinese government.

China may well remain a fertile ground for the investment over the long-term. An expanding middle class, rising incomes and technological innovation may well fuel growth.

How to invest in China

Our Select 50 includes six funds that invest in Asia and emerging markets.

1. Comgest Growth Emerging Markets Fund
2. Fidelity Asian Smaller Companies Fund
3. iShares Core MSCI EM ETF
4. Lazard Emerging Markets Fund
5. Schroder Oriental Income Fund
6. Stewart Investors Asia Pacific Leaders Sustainability Fund

There is a good case for continuing to consider an exposure to China in your portfolio. But if you want to do so, it’s worth ensuring that it’s part of a broader emerging markets exposure. Diversification is an important pillar of investing, so it makes sense to not put all your eggs in one basket.

Five-year performance table

(%)
As at 31 July
2018-2019 2019-2020 2020-2021 2021-2022 2022-2023
China CSI 300 11.6 25.1 4.3 -11.5 -1.2
MSCI World 4.2 7.8 35.7 -8.7 14.1

Past performance is not a reliable indicator of future returns

Source: Refinitiv, total returns in local currency from 31.7.18 to 31.7.23.

1 Financial Times, 22 August 2023
2 Financial Times, 22 August 2023
3 Financial Times, 23 August 2023

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. 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. Select 50 is not a personal recommendation to buy or sell a fund. 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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