Downside Over? 5 Reasons to Buy Back into China

From a portfolio construction angle, Chinese equities tend to have a strong technology tilt, but that's not the only thing that looks attractive

Christopher Johnson 26 April, 2024 | 3:54PM
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Christopher Johnson: Welcome to Morningstar Studios. Today, I'm joined by Nicolo Bragazza, Associate Portfolio Manager at Morningstar Investment Management. Nicolo, thank you so much for taking the time out to speak to me.

Nicolo Bragazza: Thank you for having me.

CJ: So today, we are talking about China. China has become an investment pariah with foreign investors in particular, so people are taking lots of money out of the country on mass due to geopolitical risk and tensions. So, why then is Morningstar backing the country?

NB: We, first of all, are valuation-driven investors. So, generally, we invest in assets that we deem as attractive from a valuation perspective. And generally, things get attractive when other investors do not want to invest in them. So that's when we carry out our research and we decide whether the investment has merit or not.

Specifically, for China, we believe there are five main reasons why we think the investment in China is worthwhile. The first is – so profit margins are at very low levels in a historical perspective, and we think there is more upside to them over the medium to long term. The second is the Chinese equity market at the moment has very attractive valuations. The third is there is a lot of embedded pessimism in Chinese equity valuations, and we think that this is misaligned with underlying fundamentals of the companies.

The fourth reason instead is more from a portfolio construction angle because when you invest in the Chinese equities, you tend to invest in companies with strong technological businesses in consumer discretionary or in communication services type of businesses and you do that at more attractive valuations compared to the US. The fifth reason, in our opinion, is the fact that although it is clear that China has gone through a very challenging macroeconomic environment, the country still retains a significant growth potential.

CJ: In which sectors are you finding opportunity?

NB: We tend to think that Chinese equities are particularly interesting because of the exposure to communication services names and to consumer discretionary names. Those companies have strong businesses, strong intangibles and significant growth opportunities ahead and they are more attractively priced than US competitors.

CJ: Are you seeing any opportunities within artificial intelligence coming out of China?

NB: I think that China is definitely going to be one of the main countries for AI in the future, also because a lot of people think that the success of a nation will depend upon its implementation of artificial intelligence across its sectors and industries. We think that a lot of hype in AI, in artificial intelligence, has been devoted to tech companies and maybe those are the winners today of the AI race. But we think that it is also important to recognise that it is very difficult to see the winners of tomorrow in the AI race. This is because AI has very wide ramifications and many companies, especially in the manufacturing and services sectors, are not yet ready to benefit completely from it.

CJ: The National Bureau of Statistics recently reported that manufacturing and industrial production significantly boosted Chinese GDP. So, do you think that China will continue to wear the crown of being the top manufacturer? Or do you think that the effects of geopolitical tensions and nearshoring will knock it off the top spot?

NB: There is no doubt that geopolitical tensions have driven a wave of concerns around China and a wave of onshoring or nearshoring for many companies because of geopolitical risks. Whether I think that China remains a very important trade nation, it is one of the most important trade partners for most nations across the globe. And also, we need to acknowledge that generally reorienting and redesigning supply chains is a process that takes a long time and needs significant investment to be pursued. So, maybe that is the case, but this is a very long-term process that can take a long time. Plus, I would also say that in some ways, this is a natural process for China, because as China has got richer, labour costs have increased and therefore it has become relatively less competitive to some other countries where labour costs are significantly lower.

CJ: On to electric vehicles, what do you think about China's growing dominance in the space?

NB: Yeah, I think China at the moment is definitely one of the leaders in electric vehicle technologies and not just in the production of vehicles but also in battery technology. So that's very important to point out. On the other side, more recently EV automakers have had a challenging period from a performance perspective, and this is likely to be driven by the fact that in the past these companies have significantly high valuation multiples. And now they have come back a bit and they are more attractive from a valuation standpoint. So that's the main thing for EV in China. China definitely has technology. The automakers have a lot of capacity to build their export around the world, but at the same time, we still think that within Chinese equities we still prefer tech companies because you still have the tech part, so the technological strength, you have businesses with high margins without the same degree of cyclicality of an automaker.

CJ: Nicolo, thank you so much for taking the time out to speak to me.

NB: Thank you.

CJ: This is Christopher Johnson from Morningstar UK.


The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Christopher Johnson  is data journalist at Morningstar

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