Dim Outlook for Chinese Equities

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Amber Sinha, CFA

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Amber Sinha, Senior Portfolio Manager Global Equities at CIBC Asset Management.

China certainly, almost every year, becomes a more and more important part of the global stock market. So definitely we have our eyes on China. So let’s discuss what’s going on there. There’s obviously the issues that are in the news and the headlines about the COVID lockdowns, and the mortgage debts, and people are not satisfied with how things are on several fronts. I think if these were the only concerns that plagued China today, I think we would be willing to buy. Unfortunately, I think there’s some more to the story there. So again, like I said in the news, it’s about housing troubles and people trying not to pay their mortgages, or being in a constant state of lockdown. I would say for the investment industry, there are two even bigger trends that have come into play in the last two or three years, and I think they matter even more than the lockdowns and the mortgage.

And they are what? One is technology. So technology companies in China, especially the handful of large-cap technology companies, have played a tremendous role in transforming that economy into what it is today in terms of the level of eCommerce, digitization, et cetera. And over the years, the government had a pretty hands-off approach with these companies, because they were net contributors to the modernization of the Chinese economy. That relationship seems to have ended last year. I think it’s pretty clear where the technology is no longer seen as an enabler by the government, but something to have tabs on. And a large part of the Chinese market cap actually resides in these technology companies. So if these companies are only shadows of their former selves, it says something about what the outlook for China is.

The second thing is housing. So that does relate to the mortgage crisis, but again, I think it’s more nuanced than just headlines on the mortgage. Housing has been the go-to investment for a lot of people in China, and it’s been a fairly profitable investment also. And this is also an area that the government has constantly used either to increase or decrease stimulus to the economy. So a lot of the stimulus that people talk about in China actually goes through the housing market. So it’s basically a very effective vehicle for stimulus in the past. Here, I see there’s another change. So just given the damage that’s been done to housing, right from the developers, the suppliers, the consumers themselves, the banks that loan the money to buy this stuff, the entire system seems to be in trouble at the same point. So I don’t think housing can be the go-to vehicle to get out of problems going forward like it used to be.

So I think these are two of the things that really change our thinking on China from what we would’ve thought two years ago.

When we look at market participants, I would say the market still has a very high level of confidence in the government of China having a good handle on things. So, because it’s a Communist country, they do what they want and do it effectively. People always have the confidence that when the right time comes, they will be able to quickly channel support for the economy, and be in a position to help the economy when the Western countries might not be. I think that’s a pretty standard thought, I would say, in the market. And here also I would disagree. I would say the political system there does not make the government very capable of handling crises, because they never have to handle crises. They don’t have to ask the public for wars, they don’t have to do a lot of things that Western governments have to. So I just don’t know if they’re that well prepared for any crisis. I think COVID is a good example where they’re doing something that’s completely unique in the whole world, and to me it’s a sign of not being able to manage this crisis the way it should be.

On the stimulus front, again, I think their main vehicle for stimulus in China housing certainly seems to be in bad shape. And so we are left with fixed asset investment. With every passing year there’s less and less room for adding more infrastructure, unless you are literally building bridges to nowhere. So I don’t think fiscal stimulus, either through housing or fixed asset investment, can have the impact that it’s had in cycles past. So we put all this together, and I will summarize it as saying that despite the declines we’ve seen in the Chinese market, it’s not a no-brainer to just get in there and buy the Chinese market.

There are pockets of the market where we are trying to educate ourselves. We are trying to get to know companies and buy them. And what are these pockets? So I think some long-term stories in China are still intact, and in fact like they have always been, the middle class stories. So people in China, their incomes increase over time, and they have been increasing over time, and they have the propensity to spend it how they like. So the Chinese middle class story I think is still up and running. Clean air, clean water, I think that’s a significant commitment that the Chinese government themselves have made to the public and to the global community as well. And they’re pushing hard on that. So that’s another theme that we like.

China, I think, is in the process of building national champions that can compete globally in several facets of the economy. So the biggest electric vehicle manufacturer is Chinese. The biggest electric vehicle battery manufacturer globally is Chinese, by several orders of magnitudes. So I think the country has been building national champions that are delivering the goals that the Communist Party of the government wants, and they tend to be in line with a well-functioning economy. So that’s where we are spending our time, as opposed to just generally buying what comes across first in China, which is the tech stocks or housing stocks.