Will China Rebound in 2023?

VIDEO: Morningstar Italy's Valerio Baselli speaks to JP Morgan's Howard Wang about opportunities, tech innovations, the end of the zero-Covid policy and US relations

Valerio Baselli 19 December, 2022 | 9:18AM
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Valerio Baselli: Hello, and welcome to Morningstar. The Chinese stock market is experiencing a rebound after a long period of underperformance. Now, investors wonder whether this is a just flash in the pan or a real upturn. To talk about this, I'm joined today by Managing Director Howard Wang. He is country specialist for Greater China Equities at J.P. Morgan Asset Management.

So, Howard, China, the world's second biggest economy, is forecast to grow at a slowest pace in about three decades. What is your outlook for 2023? Do you think the Chinese authorities will be able to solve some of the country's main problems – the local government debt burden is becoming unsustainable, for example? And if so, how?

Howard Wang: Sure. I think when we look at China and when you think about the macroeconomic problems, the main conclusion that we came to is that a lot of this was self-inflicted, because you had a real estate crackdown, you had a technology regulatory reset; and of course, you had the grand looming issue of COVID zero. Because all of these problems were self-inflicted or self-created, you can also unwind them and that's exactly what we're seeing right now, which is that post the party Congress, the Communist Party is moving very, very quickly right now to actually unwind all of these policies which have created a tremendous overhang in terms of investor perception of China and in terms of the GDP growth rate. And just specifically, for instance, on the local government debt, which you mentioned, the local government debt issue is really a function of the finances at the local government level, which are disproportionately contributed to by land sales for the real estate market.

So, to the extent that the government is now moving to a supportive stance of the real estate market, we don't expect this to be an overhang that much longer. In other words, the finances can heal themselves quite quickly if the real estate market can heal itself quickly. And a lot of this is eminently under the control of the government in terms of its policy stance and in terms of its adherence to COVID zero, which again, it's rapidly unwinding right now, which is very encouraging for markets.

Baselli: Right. And as you just mentioned, the zero COVID policy has been a main issue in China. The Chinese cities are now easing restrictions following unusual nationwide protests. How do you assess today political risk in China? For instance, could the domestic political instability and labor activism reshape how foreign companies operate in China, in your view?

Wang: Yeah. I think one of the stories about protests which probably doesn't get enough publicity in the West, is that protests in China are actually quite common, but usually they're about local issues, right? People protesting a factory polluting near their city, et cetera, et cetera. These are smaller, contained protests. And what was unusual about the COVID zero protests was it happened to be nationwide even though not that many people participated. So, in other words, if you roll forward, we already have a bit of a protest culture. I think the important thing from a protest standpoint though is you don't challenge the legitimacy of the Communist Party. But if you're, for instance, protesting about the way a local regulator interprets central government policy, that tends to actually be okay. And I think that's exactly what happened in the case of COVID zero that people were frustrated not just because of the policy, but because the central government already promulgated a loosening of the policy, but local government officials were not following it, and they were still adhering very strictly to something that was A – not really that workable practically, as we know, and then B – something that actually went in opposition to what the central government said was the direction of the country.


So, in other words, when I think about this in terms of foreign companies operating in China or general domestic political risk, I don't think things have changed that much. I think the party is very well ensconced where it is. I think Xi Jinping's seat is extremely secure. So, to me, the biggest political questions for China are not so much about domestic politics and domestic stability, but about the way that China relates to other countries, particularly the United States and its allies. That, I think, is the principal political risk. And again, I think just like all those domestic policies that weighed down on the economy, we also have better signs of that versus the way that Xi Jinping has been allowing foreign dignitaries to visit China, the way he conducted himself at the G20, particularly in his meeting with Joe Biden, again, I think, things have gone on to a better track from a geopolitical risk standpoint, and on the domestic political risk, I don't think things have changed that much.


Baselli: That's very interesting. Let's touch another important topic as you just did, actually, which is the relationship with the U.S. As you said, Joe Biden and Xi Jinping met on the sidelines of the G20 in November. It seems the meeting went fairly well, despite the tensions around Taiwan. What do you expect from this point of view, relationship between China and the U.S.? And what can be the consequences for China of a new clash with Washington?


Wang: Right. I think that we are now very much in a stage in which the United States and China will marginally decouple from one another. We're also in a stage now where the United States has decided that they cannot bring China into the liberal world order that the United States has dominated. China is going to exist inside international organizations. China believes strongly in the WTO, the WHO, the United Nations. But China doesn't necessarily buy into all the components of the liberal world order. So, we're in that stage now where we're going to see the two countries moving more in parallel. They will always be dependent on each other. The G20 meeting – the sidelines of the G20 meeting really, I think, brought that into focus.


The U.S. and China will be dependent on each other, they will be integrated, but they're going to go their separate paths. Whereas I think when China entered the WTO 20 odd some years ago, there was this expectation and hope that China would become more and more like the United States. That hope is now gone. However, what we had feared a few months ago, which is that China and the U.S. will essentially have an iron curtain or a new cold war, I think that fear is unfounded also. So, what I see is, I see exactly what the United States has talked about. China and the United States are going to be competitors. They will exist somewhat separately, from a geopolitical standpoint. They will come together for common interests, whether it's an area like climate change or where it's quite convenient and a win-win situation in certain areas of the economy. So, my expectation is, is that we will have this uneasy working relationship, like for instance, the work relationship you might have with your colleague, who you don't really like that much, but that's going to be the new normal for the U.S. and China as long as Xi Jinping is in power and China is in its current state in a way it uses itself, in a way it conducts itself internationally.


Baselli: All right. Finally, Chinese equity valuations are overall attractive right now, but there is still much uncertainty in the medium and long term. What are the sectors you like the most today and what is your approach overall to the Chinese stock market looking at 2023?


Wang: I think that China over the longer term to us is going to be in a decelerating path in terms of economic growth. I don't think there's that much argument about this anymore. So, for us, the investing strategy is really built around finding specific sectors or companies that can grow irregardless of whether China's GDP growth is 7%, 5%, 3% or 1%. Obviously, we don't expect any type of crisis type environment for China, and we don't expect China to return to high growth anytime in our forecast period at this point.


So, what are these sectors? I think one is technology, broadly speaking. Import substitution, developing domestic sources of technology, obviously, that's something that's incredibly important. And in China, there's even a word for it (indiscernible) – they want to have their own secure semiconductor supply chain. They would like to have their own secure software supply chain. And this is a pretty powerful mega trend that really dovetails with the fact that China has actually reached a state of technological maturity where it can actually have pretty good companies that operate in these spheres and then you have this kind of broad geopolitical issue behind it.


The second area we find quite interesting in China is carbon transition. This is a mega trend that's happening globally. China is a big consumer of energy. And China is also a producer of a lot of the key equipment that goes into renewables, whether it happens to be things like solar energy or whether it happens to be other cutting-edge areas. China is really much at the forefront, both as a producer and a consumer of clean energies, and in areas like electric vehicles. And then, finally, I think from a China standpoint, we are always interested in companies that are innovating within China, and that happens to be companies in areas like consumer or healthcare, where China is reaching a certain state of maturity, it's not just about consuming more, but it's about consuming better. So, technological areas are of interest to us, particularly import substitution, carbon transition and certain areas of consumer and healthcare where Chinese companies are innovating for the domestic market. These are areas that we think will be growth areas both in 2023 and going forward.


Baselli: Howard, thank you so much for your time today. We appreciate it. For Morningstar, I'm Valerio Baselli. Thanks for watching.

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Valerio Baselli

Valerio Baselli  is Senior International Editor at Morningstar.

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