At the beginning of the COVID crisis, the Chinese economy came to a screeching halt. The government banned economic activity, businesses shut down, and consumption ground to a halt. Eventually, all countries, industries, and individuals were affected by the dramatic and sudden shift in the economic landscape. The global stock markets crashed as well. Certainly, the potential ‘buy low’ possibilities increased future upside for those that handled the virus more quickly and with less permanent structural damage. Our research indicated that not only would China lead a recovery out of the global recession, but that there was a robust runway for growth in the second largest economy in the world.
One of the stigmas surrounding China, that has kept Western investors skeptical of equity investment within the country, has been the legitimacy of Chinese economic data. The communist government has every incentive to show strong economic data and growth to attract foreign direct investment and increase their ties to the capitalistic economies of the West; and history supports this assumption. China wants to be the number one economy in the world and to be a leader in certain key industries. Perhaps the global pandemic is a catalyst for this ascension.
China did not need to do as much fiscal or monetary stimulus as the western nations, including the USA. Moreover, they seemingly have reduced the virus case count to nominal numbers. Therefore, we were waiting to see certain economic indicators turn to see if their recovery is on. Several data points we watched included credit growth, rail shipments, and electricity consumption. The Bloomberg li Keqiang Index shows that from a trough of less than 2% growth in January, these data points had a record resurgence to +8-9% growth in the summer, showing the resilience and effective nature of the COVID controls put in place by the government. And even though we are still somewhat skeptical about the specific numbers, the direction is strong enough to give us enough certainty about a recovery. According to Bloomberg data, we have seen the strength of the recovery flow through to the Chinese currency as well: the yuan has shown remarkable strength in the offshore market, appreciating by nearly 7% against the US dollar since the summer peak of COVID.
These turns in the data, now all up year-over-year, are some of the reasons we are more focused on the A-share market. The A-share index, specifically, the Shenzhen CSI 300, has more exposure to companies that benefit from domestic Chinese growth. Names such as Kweichou Moutai (consumer) and Ping An Insurance (financial services) do most of their business in China and have strong correlations with the Chinese economy.
The strong economic growth has resulted in a resurgence in the Chinese equity market. According to Bloomberg data, through the end of Q3, the Chinese A-share market has outperformed the resilient US equity market by over 10%. Despite the outperformance, Chinese equities remain relatively cheap to the US at 14x next year’s consensus index earnings vs. 21 times the S&P500’s consensus forward earnings. Alongside these factors, the Asia Times reported in June of this year that the Chinese government was opening the A-share market to foreign investment by reducing the asset threshold required to apply for ownership of A-shares.
With forward asset flows on the horizon, an improving fundamental picture of the global economy, and a cheap relative valuation, we see limited downside and continued upside for A-shares going forward. So, for our first venture outside the US stock market in several years, we choose China.
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