31 Oct 2022
Fidelity Global CIO Andrew McCaffery and our locally based experts review the economic and investment outlook for China. From the upcoming National Congress to the potential easing of Covid control measures, they debate the key issues facing investors and how markets could react over the coming months.
The ideas and conclusions here do not necessarily reflect the views of Fidelity’s portfolio managers and are for general interest only. The value of investments can go down as well as up, so your clients may not get back what they invest.
Andrew McCaffery: China is in a very different position to the developed world, which is grappling with ongoing inflation. It is emerging from a challenging period of economic tightening and regulatory developments. Now, economic tightening has shifted towards stimulus, both in monetary and fiscal terms, and regulatory headwinds are also showing signs of easing. Some of the biggest challenges are those associated with its property market, but these are starting to be addressed. The upcoming Party Congress will be important in setting policy expectations for the coming year.
We are somewhat encouraged by recent developments in China. It has not experienced the same inflationary pressures as the West and this is allowing it to provide stimulus. The challenge is to get that stimulus to have the desired economic effect, given the ongoing disruption the country is suffering because of Covid. Once these problems are overcome, we should see more optimism reflected in China’s asset markets. International investors are looking to diversify their developed market exposures and with China’s central bank policy now supportive and its economic cycle shifting towards growth and stability, it looks attractive relative to other parts of the world.
Victoria Mio: Covid control policy is now the biggest uncertainty surrounding China’s economy and we are monitoring it closely. Since June, there have been two notable improvements - a shortening of quarantine times and the adoption of a standardised approach across the nation. We are now seeing green shoots in industrial activity, consumption and mobility. We are also hopeful that positive policy changes may also be announced at the forthcoming Party Congress.
Hong Kong just announced that it is ending the mandatory hotel quarantine policy, allowing new arrivals to stay in a hotel of their own choice. The quarantine measures between Hong Kong and China remain the same, but the re-opening of Hong Kong is going to increase travel between and via the two countries. Hong Kong’s Covid policy may be a testing ground for China, so if successful we can be hopeful that China will seriously consider optimising its Covid policy soon.
Vanessa Chan: We believe that it is the intention of the regulator to ensure that the physical property market remains stable. The mortgage boycott in July created instability within the system and since then, we have seen targeted policy to tackle these issues, such as funds to complete unfinished projects and support to distressed issuers.
On the developer side, we believe that companies are still in ‘self-help’ mode and need to continue to seek collaboration with the state. Ultimately, the state's influence over the sector will increase, so that there is more balance between privately-owned and state-owned enterprises. We are watching the implementation of policy support and how it will reflect in economic indicators.
Victoria Mio: Mortgages account for 20% of banks’ loan balances, while developer loans are around 6%. If the property market continues to weaken, it could cause more defaults on the developer loans. Based on our estimates, only 0.4% of the mortgage balance is at risk due to the recent mortgage boycott. Even a worst-case scenario would therefore have relatively insignificant impact on the solvency of the overall banking system. It does not represent systematic risk.
The second-degree impact on the developer loans can become serious, however. Fortunately, banks have built up strong balance sheets and high capital ratios, so we are confident that there will not be financial dislocation. However, we may see some spill over impacts on property sector supply chains, affecting things like materials businesses.
The property sector may face further pressure in the near-term but will gradually recover in the coming months. The government is aiming to implement a series of actions to ringfence the damage and restore confidence.
Andrew McCaffery: There is a difference between expectations in China/Asia and those in the US/Europe. There is the potential for sentiment to improve if we see policy move towards opening up China’s capital markets internationally.
Vanessa Chan: There will be talk of policy support. However, for property, any support will need time to work through the system. We are also likely to see some more support for domestic consumption. Overall, we are constructive that policy stimulus will come through eventually.
Victoria Mio: The Congress will not just affect short-term sentiment but will also have an impact over the next five years. It normally focuses on personnel and there are not normally major policy announcements, but policy can be indirectly affected by the top leadership. Afterwards, we can expect improved policy coordination and implementation due to the settling of personnel issues. I expect a readjustment of Covid policy, which may lead to clearer market expectations on re-opening.
Vanessa Chan: From a fixed income perspective, I think property is looking very attractive in terms of valuation. Investment grade is presenting some high-quality opportunities, if you have a long-term horizon and holding power it could be very interesting. There are also some opportunities in China and Asia high yield. Technology is also an area to watch, as we see ongoing regulatory relaxation benefit cash-rich companies that have been under pressure. China onshore bonds could also provide stability, particularly in foreign-exchange terms.
Andrew McCaffery: In investment grade you can still get diversification in terms of company quality and many high-quality Chinese businesses are experiencing more tailwinds than their international counterparts.
Technology has been beaten down in valuation, but it could do relatively well if there is a sense that the headwinds facing the sector are declining. The potential for re-pricing is quite high. Cyclical consumption ideas will also start to come back to the fore and we are seeing some signs of support for these businesses come through. We will hear a lot of noise about the renminbi weakening against the dollar, but that isn’t going to be a key component as to how policy is going to be managed.
Important information
This information is for investment professionals only and should not be relied upon by private investors. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. Changes in currency exchange rates may affect the value of investments in overseas markets. Investments in emerging markets may be more volatile than other more developed markets. The value of bonds is influenced by movements in interest rates and bond yields. If interest rates and so bond yields rise, bond prices tend to fall, and vice versa. The price of bonds with a longer lifetime until maturity is generally more sensitive to interest rate movements than those with a shorter lifetime to maturity. The risk of default is based on the issuers ability to make interest payments and to repay the loan at maturity. Default risk may therefore vary between government issuers as well as between different corporate issuers. Due to the greater possibility of default, an investment in a corporate bond is generally less secure than an investment in government bonds. Reference in this document to specific securities should not be interpreted as a recommendation to buy or sell these securities and is only included for illustration purposes.