22 Sept 2021
China’s reaction to the threat posed by COVID-19 was both swift and decisive, with Beijing shutting down whole cities and providing substantial monetary stimulus to the economy in order to offset the worst of the impact. As a consequence, China’s economy was the first to rebound from the COVID slump allowing the People’s Bank of China (PBOC) to start to normalise monetary conditions before any other major economy.
As the rest of the global economy has moved decisively into recovery mode, we believe the Chinese authorities have sought to use this global upswing as a window of opportunity to address some of the challenges that have emerged during China’s rapid transformation into the World’s second largest economy. Along with associated monetary tightening, these policy changes have caused weakness in its capital markets, most notably in the substantial property and internet company sectors.
Specifically, Beijing is attempting five major policy pivots to:
These are significant undertakings, and we believe China’s leadership is seeking to introduce these changes while the global growth picture is in relatively good health. They are effectively signalling their willingness to suffer ‘short-term pain for long-term gain’. We have already seen growth disappoint consensus expectations and equity and bond market weakness and this may well continue. Eventually the authorities will loosen credit conditions again and allow the Renminbi to weaken in order to underpin growth.
Many foreign shareholders have leapt to the conclusion that pivots imply a return to an autocratic command economy and that ‘China is uninvestable’ as a consequence. The exodus of such investors from the big Chinese internet names that have listings in America has been a major factor behind this formerly high-flying sector’s particularly brutal de-rating. Taking a step back, the rest of the Chinese equity market still appears relatively expensive, but there are already, in our view, pockets of exceptional value for those investors prepared to invest for longer term. This particularly applies to the deeply out of fashion digital leaders such as Tencent and Alibaba. We believe these are extremely well-run, well-positioned companies that are highly cash generative. Tencent – from its cash flow alone, using relatively conservative assumptions – could buy itself back in seven years at its current market valuation.
Clearly, it is difficult to have full clarity, but we do not believe that China is in the process of going back to being a full-on command economy. The Chinese authorities have demonstrated again and again that they understand the importance of private enterprise and the private sector. Given the materiality of the policy adjustments that they are undertaking, the role of the private sector will remain central to the country’s fortunes. That said, we are on notice that untrammelled capitalism in the form of monopolies and oligopolies and excessive speculative behaviour will not be tolerated. Some commentators have said that President Xi is prioritising state control over economic reform. We think the opposite is the case – state control is reinforcing economic reform.