2022 look ahead: Many reasons to be optimistic about China equities
Recent regulatory concerns have created mispriced opportunities
Wenli Zheng is portfolio manager of China Evolution Equity Strategy at T. Rowe Price. He is based in Hong Kong.
China's domestic policies were on top of investors' minds in 2021 and had a meaningful impact on several industries. Investors who were caught by surprise may ponder: Are Chinese equities still investable?
From our perspective, understanding the goals of government policies can help investors navigate the regulatory environment and China remains a fertile hunting ground for active stock pickers. We believe that attractive opportunities lie in China's rising star companies and undiscovered leaders across niche and fragmented industries.
Beijing tends to fix the roof when the sun is shining:
While the market was shocked by Beijing's policy actions in some industries, we think the government's intention has been clear and consistent.
Take the policies on property, health care and education, for example. The overarching goal is to build a more sustainable and equitable society. On the other hand, the regulations on online platforms aim to create an open, more competitive ecosystem instead of walled gardens.
The introduction of new policies may lead to short-term market volatility, but they also create emerging opportunities, such as accelerating innovation across health care and the rise of startups.
It is worth pointing out that there are cyclicality elements to China's regulatory environment. The regulator is more likely to conduct structural reforms when the underlying economic situation is strong in order to fix the roof when the sun is shining. We believe the recent countercyclical policy moves can help China's economy to become more resilient against future external shocks.
There are signs that policy restrictions are easing as the economy faces more headwinds following power shortages, sporadic COVID-19 outbreaks and disruptions caused by indebted lower-quality property developers. In our view, Beijing has enough policy instruments to engineer a soft landing for the Chinese economy in 2022, though fresh stimulus measures are likely to be selective and targeted.
"Common prosperity" depends on a larger and growing pie:
Another matter that recently raised investors' concerns is China's new goal of achieving common prosperity. In our view, it does not imply a redistribution of existing wealth from the rich to the poor. Common prosperity is neither anti-private enterprise nor anti-market.
Rather, the goal of common prosperity is to enhance social mobility and allow all citizens to participate in economic development. The prerequisite of common prosperity is that the economic pie should continue to get bigger. However, in some areas, such as the low pay and benefits of gig economy workers, the government believes direct intervention is necessary to balance the power between the big platforms and workers.
Furthermore, China property sector stress has dominated the headlines in the past few months, causing some panicking investors to flee from Chinese assets.
In our view, since property and its related sectors account for almost one-third of China's gross domestic product, some slowdown in the overall economy appears inevitable and the overall volume of primary property sales might have peaked.
However, we believe that the government has the right policy tools to avoid serious systemic risk and a hard landing, and we see selective opportunities in the developers with unique models and strong financial positions that are poised to consolidate the market. Exciting multiyear growth opportunities can also be discovered in the after-sales market, where the industry players are specialized in property management, remodeling and furniture upgrade.
Four secular trends that Chinese equities investors should not ignore in 2022:
There is no lack of investment opportunities in China as the world's second-biggest economy, but a lesson learned in 2021 is that looking beyond mega-caps may lead to a higher chance of finding future winners. This is not only because many blue chip stocks across the internet, health care and consumer sectors have pulled back meaningfully due to investors' concerns over regulation, but because these stocks were already crowded and expensive trades after the market rally in 2020.
China is a dynamic market where change is the only certainty. We have witnessed some positive secular trends in the country that are worth investors' attention.
Firstly, China's economic upgrading is shifting its competitive advantage from having a low-cost benefit to gaining a technology-driven edge. While China's demographic dividend is coming to an end, education is taking up the slack with approximately 10 million college students graduating every year, up from one million students two decades ago.
Therefore, innovation has become a critical driving force for the economy and wealth creation. Even in the traditional industrial space, Chinese companies are quickly moving up the value chain. Increasingly, they are competing on innovation and performance rather than pure cost.
Secondly, in the consumer space, we have seen the rapid rise of Chinese domestic brands. They are usually the forerunners to embrace social media and e-commerce, which offer them the opportunity to disrupt incumbents. In addition, young consumers in China have a more positive perception of domestic brands in general, which supports the growth of those businesses.
We also see tremendous consolidation opportunities in service industries, such as hotel chains. We believe that the service industry will likely be home to many future earnings compounders.
Thirdly, we think energy transition, electric and smart vehicles, and high-performing computing are three mega themes for the next five to 10 years.
This also brings a great opportunity for investors to see beyond the obvious beneficiaries such as solar stocks and electric car battery stocks, and to identify under-discovered opportunities along different parts of the supply chain at a good price, such as grid automation and auto parts, with the rising content in electric vehicles.
Last but not least, recent regulatory concerns have created mispriced opportunities and a better understanding of Beijing's long-term policy agenda can help investors navigate the regulatory environment in China.
With investors shying away from anything related to the property and health care sectors, we believe there are companies with unique business models that can navigate the environment successfully.
That includes select companies in property management services, furniture retail and medical devices. We also focus on leading players in various niche industries; many are mid-cap companies in industrials and business services segments. We expect the niche industry leaders can offer strong growth potential at a reasonable price.
Looking ahead, there are still many reasons to be optimistic about Chinese equities. China is a deep market with over 5,300 listed companies, offering a huge opportunity set to investors.
We believe, looking beyond the mega-caps and focusing on identifying the rising stars and future compounders will be key.