Investors started the year bristling with optimism over China’s prospects as the country’s Covid lockdowns ended and feeling pessimistic about the US after a tough 2022 that saw New York’s tech-focused Nasdaq crash by a third.
So far, the year hasn’t turned out how investors expected.
After a bright first quarter, Chinese growth slowed while US tech shares skyrocketed on the back of the artificial intelligence boom.
The iShares Core S&P 500 ETF soared 20.12 per cent in the year to August 1, while the iShares MSCI China ETF rose just 3.82 per cent.
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Today, attitudes have reversed. Only 6 per cent of analysts reckon China's stock market is the best positioned for the rest of the year, while more than a third favour the US, according to the Natixis Centre for Investor Insight.
Are investors about to call the second half of the year wrong, too? It’s possible.
Today, US shares look expensive with the S&P 500 trading at more than 30 times earnings, while MSCI China is valued at just 10 times, the lowest in a decade.
China may be close to an inflection point after the government pledged to support the country’s “tortuous” economic recovery, says Jeremy Batstone-Carr, investment strategist at wealth manager Raymond James.
“It outlined numerous challenges, including insufficient domestic demand and weak demand for the country’s exports. The simple recognition that there is work to be done was enough to buoy markets,” he adds.
With investor exposure to China near record lows, he suggests this may be too good an opportunity for investors to pass up.
US Treasury Secretary Janet Yellen’s recent meetings with high-ranking officials in Beijing raised hopes that relations between the world’s two economic superpowers may thaw slightly, but they look set to remain frosty.
Investors should not put too much faith in fiscal and monetary stimulus, either, as the “low-hanging fruit has now been picked”, Mr Batstone-Carr says.
“Projects thought likely to generate the greatest return on capital have now been completed, while bailing out troubled property developers has diminished resources for new infrastructure projects.”
Instead of “big bang stimulus”, expect to see modest and targeted measures, Sophie Altermatt, an economist at Swiss private bank Julius Baer, says.
So far, this includes minor rate cuts by the People’s Bank of China, tax cuts for the corporate sector and product-specific consumption incentives, notably for electric vehicle purchases.
The market is waiting for more “concrete measures” before breaking out, Ms Altermatt says, while recommending Chinese dividend stocks and sectors that are less correlated with economic cycles, notably electric vehicles, online games and travel.
The consensus view of the Chinese economy may be too negative, says Andy Rothman, investment strategist at the Matthews Asia fund.
Analysts have underestimated the resilience of Chinese consumers and entrepreneurs, as well as the pragmatism of the country’s policymakers, he adds.
“As Covid memories fade, consumers should regain more confidence, supported by high savings and strong income growth. A gradual, consumer-led economic recovery is likely in the coming quarters.”
Never underestimate China, Mr Rothman says, noting that western analysts have been forecasting a meltdown for years, starting with Gordon G. Chang’s 2001 book, The Coming Collapse of China.
“Similarly dire predictions for China’s economy were common during the global financial crisis, the Donald Trump trade war and Covid lockdowns,” he says.
Yet, between 2001 and 2022, income per head rose 4.6 times in China as its economy accounted for a third of total global growth, larger than the US, Europe and Japan combined.
In times of trouble, Chinese pragmatism has prevailed, Mr Rothman says.
While recent quarters have been “rough”, between 2012 and 2022, China recorded average annual real income growth of 6.2 per cent, against 1.4 per cent in the US.
While it is unlikely to return to the glory days of double-digit gross domestic product growth, patient investors could reap the rewards of recovery.
High unemployment among young people remains a concern, as is China’s debt-to-GDP ratio of 297 per cent, as measured by the Bank for International Settlements.
This is higher than Germany (190 per cent) and the US (256 per cent), but below Canada (305 per cent), France (334 per cent) and Japan (414 per cent).
“Cleaning up China’s debt problem will be expensive and does limit the government’s options for fiscal stimulus, but will not likely lead to the dramatic hard landing or banking crisis,” Mr Rothman says.
He concludes that while “it’s unfashionable to be optimistic about China’s economy, the consensus view may be too negative”.
Investors looking for opportunities may note that among Chinese mega-caps, Tencent Holdings is up a modest 6.62 per cent this year, with Alibaba Group up 5.08 per cent. That’s a far cry from the US tech surge.
Private investors should examine their portfolios to see how much exposure they have to China, and then see whether it is time to buy at today’s low prices.
Most will prefer to spread their risk with a broad-based exchange-traded fund, such as the iShares MSCI China ETF or SPDR S&P China ETF, or a sector-focused fund such as Invesco China Technology ETF, Global X MSCI China Consumer Discretionary ETF or WisdomTree China ex-State-Owned Enterprises Fund.
Alternatively, they could cast their net more widely with an emerging markets fund such as the iShares Core MSCI EM IMI UCITS ETF, which has a 27.8 per cent weighting to China. That’s far higher than its 15.5 per cent weighting to India and 15.1 per cent to South Korea.
While China has its challenges, contrarian investors who like to buy low and hold on for a long-term recovery may decide that now is the perfect time to invest, before others wake up to the opportunity, rather than afterwards.
Investors may wonder whether the US market, close to record highs, may be one to avoid for now.
While timing the market is tempting, as ever, there are no guarantees. In the long run, investors need exposure to both economic superpowers.
