After navigating the Covid crisis relatively well, a degree of normality has returned to China. This may bode well for its economy and stock markets.
Yet this is precisely what I found on my recent visit to Shanghai from Hong Kong. In fact, traffic congestion was as bad as it was in the old days, before the need for lockdowns and other restrictions. Restaurants, meanwhile, were once again packed. Besides the mandatory two-week quarantine on arrival, I saw few signs of the health crisis.
We think the recovery will continue, aided by supportive policy and a robust test and trace programme.
After shrinking 10.0% quarter-on-quarter (q/q) in the first quarter of the year, the economy bounced back in the second quarter, expanding by an impressive 11.5% q/q.
Industrial activity has led the recovery, and manufacturing is returning to more normal levels of operation. Although data in areas such as retail sales have also improved persistently, the consumer sector has lagged; partly due to weakness in areas such as travel.
Overall, China has navigated the crisis relatively well, and apart from interactions with other countries, most domestic activities are back to a pretty normal state.
WHAT IS THE OUTLOOK FROM HERE?
We think that economic activity will remain strong over the next few quarters at least. This is underpinned by the proactive steps taken by the government earlier this year, in response to the impact of Covid-19.
In order to restart and support the economy post the pandemic, various stimulus measures were unveiled, with budget for additional spending earmarked.
This included a special purpose bond issue from the central government. In addition, prior to the pandemic, the government had already increased the local government bond issuance quota.
Monetary policy easing from the People’s Bank of China earlier this year should also prove beneficial, though there is typically a lag before its impact is visible.
WHAT ARE THE RISKS?
As with other countries, the reality is that the risk of a resurgence in the virus remains. This could result in renewed restrictions on movement and a consequential impact on economy. However, China has so far proven adept at bringing down and controlling infection rates.
Geopolitical tensions, on the other hand, appear likely to persist. And there is a risk we see further escalation, and this may be in the form of further restrictions on the technology sector, for example.
And while such measures may have some impact, not least on sentiment, we think the economic impact would be manageable. The domestic economy, for example, is increasingly driven by what the government calls ‘internal circulation’ or domestic production, distribution and consumption.
WHERE ARE THE MARKET OPPORTUNITIES?
The market has performed strongly so far this year. But that’s not stopping us continuing to find attractive opportunities in the China A-Shares market.
We have for some time favoured companies which we believe are best positioned to benefit from long-term growth trends. These are in sectors such as electric vehicles, a multi-year secular story in our view, as well as 5G and industrials which are beneficiaries of automation.
We are seeing Chinese companies become more self-sufficient, increasing investment in research & development, and becoming more competitive in the longer term.
If the economic recovery continues to take hold, and gathers momentum in 2021 as we anticipate, there may be opportunities among sectors more sensitive to the economic cycle, such as materials.
In sectors that are forecast to grow strongly regardless of wider economic growth, there are undoubtedly cases where valuations are elevated. Nonetheless, even in these sectors we are still finding companies whose growth potential remains underestimated.
Investment involves risks. This material is issued by Schroder Investment Management (Hong Kong) Limited and has not been reviewed by the SFC.
