Catching a Dragon’s Tail: How We’re Positioned for China’s Post-Pandemic Resurgence
Written by Cameron Scrivens & Kai Lam
Over the past two decades, no country other than China (with the possible exception of the United States) has played a more important role in defining global growth. So as the country puts an end to its constrictive zero-Covid policies, it is incumbent on investors of all stripes—even those with a more domestic-focused portfolio—to keep one eye on the ripple effects coming out of the Middle Kingdom.
In the end, the Communist Party of China (CPC) succumbed to the same forces that gripped Western governments, only later and following a longer period of even more Draconian restrictions. Civil unrest is anathema to Beijing, and when sustained protests erupted across the country in December, it wasn’t long before the world’s second-largest economy was reversing course on a stringent set of policies designed to contain Covid-19.
We were surprised at how fast they did this. The zero-Covid policy had been in place a very long time, and President Xi Jinping reiterated support for the protocols not long before much of them were lifted.
Yet China vastly underperformed its own growth estimates last year, posting an expansion of just 3% compared to an original target of 5.5%. Combined with the release of the latest demographic data that showed outright population decline—spotlighting a shrinking working-age population—there is a sudden urgency for the Party to project a sense of growth and vitality.
As investors who closely study international markets, we have been positioning ourselves for China’s reopening—benefiting already from International markets’ relative outperformance compared to the S&P 500 and TSX composite index that began in Q4 2022.
In our view, that outperformance has plenty of room to run. And we are not alone in that perspective—gross domestic product in emerging markets is expected to grow 1.4 percentage points above the rate of advanced economies in 2023, according to JPMorgan strategists.
Chinese cities and companies are enduring now what Western economies withstood in 2021 and early 2022, with rising infection rates expected to temporarily drag on productivity. This should prove short-lived. Investors would do well to gain exposure to firms that will gain from a Chinese economic resurgence fueled by the twin engines of domestic consumption and rising industrial output—both of which, in our view, will propel earnings growth that will comfortably surpass U.S. and Canadian stocks this year. We expect China’s GDP to end 2023 back on its longer-term growth trend of 5-6%.
Recall, a locked-down China has sidestepped the worst of global inflation, with no need to tighten monetary policy as other central banks have. A savings glut among households is also waiting to be spent. Though not to the same scale as stimulus-laden American or Canadian consumers, many millions of middle-income earners in China are in a position to deliver a meaningful burst of domestic demand. Chinese consumer stocks remain undervalued, in our view, as do technology and cyclicals with names like Alibaba an Tencent firmly on our watch list.
To underscore the point, while most of the U.S. market index is priced at more than 19 times trailing 12-month earnings, emerging markets, led by China, is only around 11 times, according to Morningstar’s EM index.
We also like companies domiciled outside of China that stand to benefit from a significant exposure to the region within their underlying businesses. Take the luxury fashion operator LVMH (Moet Hennessy Louis Vuitton SE). It a European company, of course, but with brands that the Chinese post-pandemic consumer is ready and willing to splurge on. We favourably view firms of its ilk, that have significant exposure to China’s recovery yet are less exposed to the country’s strong regulatory controls. There is some political risk in having direct exposure to Chinese stocks, which can be subjected to the whims of Beijing and its willingness to exert control over a firm’s fortunes, figuratively and literally.
That said, there are multiple companies both within China and dispersed globally we’ve identified as investment opportunities to capitalize China’s resurgence this year, and we’re confident our portfolios will demonstrate this over the balance of 2023.
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