FAISAL RAFI: Don’t cancel China, sell-off is an over-reaction by foreigners

China’s hugely anticipated 20th Party Congress in October concluded with Xi Jinping securing a third term as the party leader and an extensive reshuffle of the politburo. Cementing control of the Chinese Communist Party (CCP), Xi now has allies in all his committee members.

Immediately after the event, there was significant sell-off, especially by foreign investors who viewed the politburo appointments as unfavourable and counter to a reformist agenda. On the Monday after the congress, Hong Kong’s Hang Seng index fell 6.4%, and the Golden Dragon index of US-listed Chinese companies fell 14.4%, driven by panic selling by foreign investors.

Similar falls were noted in other China-heavy companies like Naspers, parent company of Tencent, which was hammered that day, falling as much as 17%. On the other hand, locally listed China A shares were far more resilient, down only 2%. So, why the panic?  

International investors were hoping for better news from Xi, such as the relaxation of the zero-Covid policy stance and further insight into the stressed property sector.

Even though the CCP went to considerable lengths to keep expectations down, when there was no such news and with the perceived negative slate of new politburo members, this led to a fire sale of foreign-listed Chinese shares. Shares recovered over subsequent days, only to fall again as US tech giants delivered disappointing earnings, barring Apple. This volatility is expected to continue.

Keep calm and carry on

There is no doubt that the party congress outcome paves the way for Xi to continue with the policies he strongly believes in, whether they be “common prosperity”, his view on national security, or stabilising and managing the property sector over the medium term. However, most local managers would argue that was already the case even before congress, and portfolios are positioned to reflect this.

Contrary to the market reaction by international investors, feedback from specialist China managers that RisCura allocates to reveals a less bearish sentiment, as they argue geopolitical risk is already well priced into Chinese equities.

In addition, the current rout is far from fully reflected in the share prices of global companies that rely on selling to the world’s largest population or on manufacturing and imports from China.

For example, a recent Bloomberg article estimated that it would take Apple eight years to move just 10% of its production capacity out of China. Apple is not the only company that will be affected in this way. Almost all manufactured products consumed by the West have Chinese-manufactured inputs or components. It took 30 years to move manufacturing to China, and it will take a long time to reverse this — if it is possible at all.

China’s future prioritises economic growth

There are several upcoming policy meetings where clues for new economic policies and growth targets may be found — the politburo meeting and Central Economic Work Conference (CEWC) in December 2022 and the National People’s Congress (NPC) in March 2023.

With the politics of appointments over, the Chinese government is expected to refocus on the economy and look to further ease the zero-Covid policy in due course. Furthermore, the macroeconomic environment and market weakness may prompt the government to roll out more pro-growth policies. 

With Xi fully in control, we could see more effective implementation of policies, even allowing for bolder reforms in the long-term. As highlighted in his report, continuous reforms and high-quality economic development remain high priorities. It noted that “by 2035, China’s per capita GDP will increase significantly, reaching the level of mid-tier developed nations”.  Instead of total country GDP growth, the focus is on the growth of GDP per citizen.

In addition, three of the committee members, including the expected premier Li Qiang, were previously provincial or central government ministerial level party secretaries in the most developed regions of China. With the president’s full support, these loyalists may have far more discretion than their predecessors.

Hong Kong’s recent move to remove quarantine requirements for international travellers and Macau’s reopening to tour groups from mainland China are further positive signals to a gradual reopening of the country.

Fast-growing companies are cheap

While it is important to understand the macro environment and watch out for policy changes, we believe Chinese equity markets offer a wealth of opportunities and the managers we work with are seeking exposure to select high-quality Chinese businesses.

Many of these companies are trading at historically low multiples. These companies are already delivering on earnings expectations, despite being beleaguered by negative Chinese sentiment.

It is our view that their composition will look vastly different in the next decade. For instance, given China’s long-term goal of building national strength and independence in science and technology, sectors such as semiconductors and renewable energy will continue to benefit from policy support. High-quality consumer companies will also likely recover as Covid-19 lockdowns ease.

Recent market activity has shown that extreme emotions can result in considerable volatility in Chinese equity markets. However, on the ground, high-quality companies continue to grow and create investment opportunities and significant value for long-term investors.

• Rafi is head of global investment research at RisCura.