Investors had hoped for a strong revival as China finally emerged from some of the world’s most stringent Covid lockdown rules earlier this year. However, the recovery has proved underwhelming so far.
After an initial bounce in April, share prices have fallen again with the MSCI China Index falling 10.7% for the year to date.
Despite the rocky recovery, Dale Nicholls, portfolio manager of the £989m ($1.28bn) Fidelity China special situations investment trust, believes it is far from over, though a robust stock-picking approach is critical to navigating the market.
“While some commentators have characterised this as a ‘value trap’, this is not our view,” he said. “Certainly, there are areas of distress and companies with structural challenges. However, we are finding plenty of companies with a strong pathway of growth, trading at attractive valuations in this environment.”
He said: “Initial expectations of the recovery were almost certainly too high and recent data reflects a bumpy return to normality for the Chinese economy. The profound impact of the zero-Covid policy for China’s citizens cannot be underestimated and it will take time to emerge fully from the dislocations it created.
“There remains relatively low confidence among Chinese consumers and little propensity to spend. Confidence plunged during the final months of the zero-Covid policy and while it has bounced higher, it remains very low versus historic trends. We don’t believe this is permanent, but recovery will take time and some patience is needed. Savings levels have been boosted significantly, thus dry powder is there for consumption to recover with any improvement in confidence.”
Despite the low levels of spending, Nicholls sees opportunities in consumer-facing sectors.
At the end of June, consumer discretionary holdings made up 38.5% of the trust’s portfolio.
Speaking at a media event in London on 18 July, he argued the recovery will be staggered, comparing it to the letter ‘k’ with the performance of different sectors diverging away from each other.
Nicholls added: “Some sectors look set to do well, while others will continue to lag. We also see gaps opening up between winners and losers, driving increasing market consolidation. This is informing our approach to the Chinese markets.
“For example, Chinese consumers are more interested in services over goods. This is understandable. Having been confined to their homes for two years, many want to eat out, or travel, rather than buy more things. This has led us to focus more on areas such as tourism in the Fidelity China special situations portfolio.”
Chinese consumer sitting on ‘unspent war chest’ of savings
In 2023 so far, the investment trust has lost 11.9% in comparison to the IT China/Greater China sector average’s loss of 19.3%. The fund is also a top quartile performer over one and 10 years, according to FE Fundinfo.
Explaining the trust’s current positioning, Nicholls said: “Where we have exposure to spending on goods, it is in areas where demand has been extremely resilient. We have seen strong demand for jewellery, for example, with many buyers seeing it as a store of value in uncertain times.
“We hold a retail jewellery group in the portfolio that is currently seeing strong market share gains. Demand for certain branded consumer goods, such as Coca-Cola has also been resilient, with demand holding up even through the pandemic. We have a Coke bottler in the portfolio.
“The headline data does not tell the whole story. The Chinese consumer segment is complicated. It is a large and populous country, with significant divergence between regions. The successful consumer companies are those that can find pockets of demand as consumer spending revives and provide value to them.”
Taking a wider view, he believes there are more reasons to be positive on the Chinese economy.
Nicholls added: “Inflationary pressures remain limited. Consumers appear to be increasingly price conscious, which is impacting some mid-tier products and services. Competition is increasing everywhere – in e-commerce, electric vehicles, or energy storage for example. Even with some labour cost inflation, these factors are acting as disinflationary forces, keeping costs low for consumers.
“The lack of inflationary pressure also gives the central bank plenty of flexibility to ease monetary policy should domestic demand remain weak. This could be in the form of local, bottom-up government support or more central government spending. Either would help revive confidence in the consumer and corporate sectors, and support the recovery.
“While there is definitely a confidence problem for the Chinese consumer, they still have an unspent war chest of savings, they are still getting richer, and there is still likely to be improvement ahead. However, the recovery will not be evenly spread, and investors will need to be careful on the winners and losers.”
This story first appeared on our sister publication, Portfolio Adviser.