Some bright spots are starting to emerge for China following a tempestuous 2023, marked by geopolitical uncertainty, deflation and property market woes.
These came in the form of better-than-expected GDP data, industrial sector growth and household spending rising by 8.3% year on-year in Q1.
GDP figures released in April showed a 5.3% increase in the first quarter of the year, beating market forecasts of 4.8%. This was driven by 6% growth in the industrial sector, with a more conservative 5% expansion in the services sector.
While positive signs emerged, the series of hard-to-shake macroeconomic factors have remained firmly in place. The property sector remains weak, with real estate investment down 75%, property sales value falling 63% and housing construction starts down 33% in the quarter compared to 2019 levels.
Geopolitical risks also continue to linger as US tariffs and Taiwan tensions prompt companies like Apple to shift iPhone production to India.
With Q1 data complicating the discussion of whether investors should allocate to China, ETF Stream spoke with fund selectors to find out how they are navigating this evolving landscape.
Growth story remains intact
Xiaolin Chen, head of international at KraneShares, said the structural growth story for China is still evident when speaking to clients on the ground in April.
Chen noted that one client in particular – a senior executive at a Chinese bank – was concerned at the beginning of 2021 that China’s policymakers would not do enough to support capital markets and the economy following the pandemic.
“Three years later, [the client] has witnessed all the policies, announcements and liquidity being put into the market,” Chen said. “His concerns now are that his own investors will not have sufficient or adequate allocations to China to benefit from the rally. That is a good problem to have.”
Conversely, Andrew Prosser, head of investments at InvestEngine, said the economic growth rate in China “does not look promising” and there remains “plenty of reasons for caution”, citing the beleaguered property sector, demographics and geopolitical tensions.
Despite this, he noted the market is “well aware” of the risks that lie inherent in China and has priced the region accordingly. “Valuations are therefore at historically low levels, which can be a signal for strong periods of growth,”
Prosser explained. “Low starting valuations, while not being a strong indicator of short-term returns, have relatively high correlations with long-term returns, particularly over the following decade.
“Given China is trading on a forward price to-earnings ratio (P/E) of just over 10x earnings and a price-to-book ratio (P/B) of 1.1x, compared to the US which is trading on a P/E of 23x and a P/B of over 4.5x, value investors may find the region attractive.”
Economy woes less relevant?
With the structural growth arguably intact, bolstered by encouraging Q1 data, investors must now grapple with the added complexity when choosing to allocate to the region.
On the flip side, the persisting view of China’s tattered economy might be less relevant to investors than it is being portrayed.
Manish Singh, CIO at Crossbridge Capital Group, said people can often forget the economy is distinct from the market, or at least that there is not a “significant link”.
He said the stock market goes through ebbs and flows based on liquidity, how many buyers and sellers are in place and what new money is coming in. “This is even more important when you look at China’s economy, the capital market is not fully integrated and fully free floating as we see in the Western world.
So, we always have been very careful about that.” Prosser agreed, adding: “While the outlook does not look promising for Chinese economic growth, the research on the relationship between economic growth and stock returns has found that there is not a significant link.”
He noted this is crudely outlined by comparing the performance of the Chinese stock market versus the S&P 500 over the last 20 years. China’s economy has outpaced the US, yet US stocks have dramatically outperformed.
A balanced allocation view
While the economic growth rate in China does not look promising, Prosser said it does not mean investors should ignore China entirely.
“Investors should avoid underweighting China due to anticipated declines in its growth rate, and similarly, they should not overweight India, or any other region, based solely on expectations of faster economic growth,” he said. “Instead, the starting point for investors should remain the global market capitalisation weights.”
Francis Chua, fund manager at Legal & General Investment Management, said the question of whether to allocate to China depends on the duration of the hold. “China should be part of a long-term strategic hold and lies firmly in the category of getting a broad exposure to a global universe,” he said.
“From a short-term perspective, however, we would make the argument that maybe now is not the right time to be bullish on China.”
Conversely, KraneShare’s Chen argued the low valuations of Chinese equities present an “attractive entry point”.
Chen’s argument for this is three-fold. For the “representative” Chinese equities like Alibaba and Tencent, she said every person in China is a customer, and therefore, this is more representative of China’s economy.
Meanwhile, Alibaba has consistently demonstrated strong financials and solid earnings over the last 12 months, while valuations remain at decade lows.
Finally, Chen added the belief from executives in the growth of these companies is shown through regular share buybacks.
The final word
While investors remain divided for now on the merits of a China ETF allocation, a balanced approach might be the most suitable course.
For example, Prosser said holding China as part of a broader EM allocation will ensure both potential upside from the country’s low valuation, but also will ensure exposure to “economic leaders”, namely India. “Remaining diversified is crucially important given volatility in these regions is likely to remain elevated for some time to come,” he said.
Looking more broadly, Singh argued China is predominantly not English speaking and this can create a disconnect between the worldview of the country and what is actually happening on the ground.
“The problem – in terms of understanding and miscommunication – is not unique but it does happen where languages are involved, and [China] has to learn to communicate with the Western world better if they want us to know the full story.”
This article first appeared in ETF Insider, ETF Stream's monthly ETF magazine for professional investors in Europe. To read the full edition, click here.
