What's the story with putting my money back into China?

Local and international punters always like to hear of the latest thaw in the Frosty Fruit-flavoured friendship between Australia and China.

During a quiet session, news that their respective governments are suddenly forwarding discussions around the removal of tariffs on Australian barley can did have reverberations through the local bourse.

China-facing stocks enjoyed a Penny Wong bump on Tuesday – with the Foreign Minister revealing plans for a first Chinese official …in ages helping boost local firms like A2 Milk Company Ltd (ASX:A2M) and Treasury Wine Estates Ltd (ASX:TWE).

The FM flagged such talks could expand to other Aussie exports, including wine, which was both a given and enough of a nudge to lift Treasury Wine Estate shares 4% higher.

Treasury Wine was all but decapitated back in 2020 after the diplomatic spat which began around the origins of the COVID-pandemic descended into some kindergarten name calling and eventually punitive trade measures.

These included tariffs Australian grain of up to 80%. That was 3 years ago, if you can believe that’s the pace a dull life can move at.

At the time China fibbed that the measures were just the culmination of an multi-year investigation into persistent Aussie anti-dumping suspicions. Our guys said it was just mean and would hit brave Aussie farmers for half a billion a year.

With so much shared prosperity at stake, both sides have just about deserved each other.

Another local beneficiary of a Chinese economic resurgence could be the international student placement provider IDP Education Ltd (ASX:IEL).

In the half year to march, IDP grew revenue across all of its product lines, with a 63% increase in student placement dollars, driven by a student volume growth up over 50%.

Here at home the small cap’s local placements enjoyed accelerated growth as Chinese students inched their way back, increasing by 128% from the first half of ’22, and just as IDP also completed its acquisition of Intake Education, a student placement agent operating across Africa and Asia.

After falling by 5.5% last year, CommSec economists reckon the ASX could lift 4-7% over the coming year – depending on the uncertainty of inflation, interest rate rises – and the real dark horse/black sheep of ’23 – the shape of China’s economic recovery.

Market economists polled by Bloomberg see Chinese growth of 5.3% this year.

Managing Director of the International Monetary Fund (IMF) Kristalina Georgieva, said in Washington over the weekend that global growth will stay crap at around 3% over the next 5 years, (well below the 3.8% average) but within that you can thank both India and China, who combined will provide 50% of all that growth.

Aviva Investors senior multi-asset and macro strategist David Nowakowski, believes China’s year could be stronger still, pencilling in growth of 5.6% or higher.

So, are we good to go?

With Beijing having signalled it is ready to take additional steps to stimulate spending and investment, and with households having been forced to save during last year’s extensive lockdowns, equities in China have provided the expected fireworks since flinging the economic levers back on.

Okay.

The reopening’s not been without its hiccups and bumps and displays of Digital Totalitarianism, but on the whole it’d be hard to argue with an MSCI China index which had gained near 40% in the four months to the end of February.

The rapid reopening policy in China allowed consumption and mobility to quickly normalise in the first few weeks of 2023, says Seema Shah, Chief Global Strategist at Principal Asset Management, but will it lead straight to further economic success in China this year?

“While the economic impact has been immediate, the potential scale and longevity of this consumer-driven rebound may hinge on how willing households are to draw down their excess savings.”

During the three COVID years (2020-2022), an uncertain economic outlook, battered confidence, and rolling lockdowns led Chinese consumers to spend less.

Consequently, saving rates were on average 4% higher than they were from 2013-2019 (33% vs. 29%, respectively), accumulating per capita excess savings of roughly RMB 4500—equivalent to 5% of GDP.

“Today, with greater certainty around the path for future income, consumers are likely to gradually tap into their excess savings—in turn, improving the corporate earnings outlook.”

However, Seema adds with a word to the wise, fully unleashing pent-up demand may be a slow process considering the following headwinds:

With the memory of repeated COVID lockdowns still fresh, many consumers may remain cautious
China’s aging population suggests rising saving rates could be a secular trend, subduing the likely spending rebound
The shape of the housing recovery, a key driver to consumption, is still very uncertain

Although the precise mechanisms by which the Chinese government will look to stimulate activity remain unclear, says Aviva Investors’ David Nowakowski, most expect it to focus on trying to boost household consumption and certain types of infrastructure investment.

Those same economists polled by Bloomberg see retail sales growing 8% and fixed asset investment 5.8 per cent in 2023.

After a sluggish kick off, with economic activity was held back by high rates of COVID infection, anecdotal evidence suggests a strong rebound is underway.

High-frequency data points to activity being well above pre-COVID levels in a wide range of household and business activities. Meanwhile, manufacturing expanded at its fastest pace in more than a decade in February, according to the latest purchasing managers’ report.

Pent-up household demand

Nowakowski expects growth to be especially brisk in the first quarter, given pent-up demand from households and the fact this time last year numerous Chinese cities experienced lengthy lockdowns to prevent the spread of the Omicron variant.

“The first-quarter numbers are pretty much guaranteed to be impressive. Just returning to a normal trajectory means you get very strong short-term growth, maybe as much as ten per cent annualised,” he says.

The improved outlook has propelled Chinese equities sharply higher.

The MSCI China Index, having slumped to its lowest level in more than a decade at the end of October, had within the space of three months surged 60% in local-currency terms.

On the China-side of equities, Will Malcolm, global emerging markets equity fund manager at Aviva Investors, likes the look of Tongcheng Travel.

Will says the strength of the rally reflects both the rapid pace of re-opening and the fact valuation metrics, such as price-to-earnings (P/E) ratios, had been driven to historically depressed levels in October.

“The pace of re-opening has been far faster than anyone would have expected.”

That said, Will reckons Chinese shares were arguably being priced too cheaply, even allowing for the combination of the zero-COVID policy and anxiety that China’s increasingly authoritarian regime was making the country “uninvestable.”

“There was a compelling case for building stakes in several companies, especially those best placed to benefit from the re-opening.

“Tongcheng Travel. Even if the stock might at first glance have appeared to be trading at an appropriate P/E ratio, he says earnings expectations for the domestic travel company were too low,” Will says. “We felt the company was almost certain to see a big earnings recovery once people were able to get out and about and travel.”

Adrian Lewis, senior investment analyst at Aviva Investors reckons China’s AIA Group was another company seen as having an improving narrative.

“The stock’s valuation had fallen to a level not seen since Asia’s leading insurer had floated a decade ago unlike its domestic and international rivals, the group’s maintained its workforce despite lockdowns preventing face-to-face meetings between clients and agents, shows resilience and adds to the attraction.

“Struggling to maintain state welfare and retirement plans, Beijing wants the private sector to take up the slack. We see AIA as being far better prepared to tap into growing private sector demand for pensions and insurance protection in the post-COVID world.”

Trend growth heading lower

However, Nowakowski cautions that even if the abandonment of zero-COVID prompts a rapid recovery in activity, it is important not to lose sight of the fact trend economic growth is heading inexorably lower. While the first half of the year may prove stronger than expected, the second half could disappoint.

“I think the real question is once you get that v-shaped rebound, what’s the trajectory that follows? Looking ahead to next year, growth might be closer to four per cent than people expect,” he says.

“Unlike the previous two deep economic slowdowns, the government is unlikely to look to the property sector to reinvigorate growth as it is not productive enough,” Nowakowski says.

Malcolm says while the re-opening of the economy may have brought some normality back to the property market, the fact remains buyers’ mindsets have changed after the government in recent years stressed housing is for living in and not for speculating and investing.

“While government efforts to ensure everyone has a home could help boost demand, there are a lot of properties being held for investment purposes that are likely to eventually find their way onto the market,” he says.

The IMF’s forecast is close to the 2023 GDP growth target of about 5% plucked out of the air during last month’s annual two sessions.

“With China absorbing about a quarter of exports from Asia and between 5 and 10% from other geographic regions, the reopening and growth of its economy will likely generate positive spillovers,” the IMF said in its quarterly report.

Countries like us (not the US) with stronger trade links and a penchant for Chinese tourism spend are likely to have even greater positive spillovers, the fund said.

Global game

China’s size means the re-opening of economic activity is likely to reverberate far beyond its own borders, Aviva suggests.

For instance, travel bookings by Chinese residents during the Lunar New Year holidays surged 640% from the comparable period the year before, according to Trip.com Group’s Chinese-language booking website, Ctrip.

(I think – most interestingly – Bangkok, Singapore, Kuala Lumpur, Chiang Mai, Manila and Bali were the top destinations. A South East Asian banquet of unexpected proportions.)

Nowakowski reckons a surge in Chinese tourist numbers will put upward pressure on inflation in western economies too.

“Lots of Chinese people, especially among the middle class, have not been able to get out since the pandemic. Any recovery in Chinese tourism is likely to have a pretty big impact on leisure and hospitality businesses in many countries,” he says.

However, while the government may look to boost spending on public housing and other areas of infrastructure, such as renewable energy plants, it’s really unclear right now if this’ll provide as much of a kick to global commodity markets as some might anticipate.

Given the steep recent recovery in share prices, Malcolm believes investors “should be discerning about their exposure” to the fun and games of the Chinese market.

Still, he argues Chinese equity valuations are “far from excessive,” especially when so very, very many of the fulsome international investors remain underweight the market.

Even if the rapid recovery in economic activity proves to be only temporary, he’s a believer there’ll continue to be China investment opportunities for the bold.

“The universe is so deep and so broad there is always going to be an opportunity to stock pick. With China representing as much as a third of the global emerging-market equity universe, it is unlikely we are going to say China is uninvestable and in danger of becoming another Russia in the eyes of global investors,” Will Malcolm says.

China is nothing if not dynamic.

Once the zero-COVID nonsense sapped the Chinese people’s mobility, joie de vivre and broader economic activity a la Q4 2022, the impact of loose headwinds blowing in from the disabled tech sector, property market stress social unrest or geopolitics made action a neccessity. And the Chinese Communist Party may have many faults, but indecisiveness is not the first that comes to mind.

“The Chinese authorities have responded with a variety of measures, including additional monetary easing, tax relief for firms, new vaccination targets for the elderly, and measures to encourage the completion and delivery of unfinished real estate projects,” the IMF says.