China pivot: From structurally bearish to tactically bullish

Equity Insights offers research and perspectives from Putnam’s equity team on market trends and opportunities.

This month’s author: Brian S. Freiwald, CFA, Portfolio Manager

After a difficult 2022, our outlook for emerging market equities has brightened. While the year is off to a strong start for EM equities, many investors are focused on China, which has faced its share of headwinds. Noise around China hit a crescendo last October when Chinese leader Xi Jinping was reappointed for a historic third time. The subsequent appointment of a one-sided Politburo and Standing Committee caused widespread speculation that we may experience an extended period of regulatory overhang. However, we believe, for several reasons, that the bear case for China may be off the table for now:

  • China’s economy is rapidly reopening
  • The government is providing a backstop to the real estate market
  • Negative regulatory headlines have taken a pause
  • Policy changes could serve as tailwinds

    For China’s equity markets, we are bullish about three key changes since Xi’s appointment.

    Zero-Covid exit. The abrupt end in December to China’s stringent pandemic lockdowns has market observers questioning what it means for equity markets. We believe the positive effects of China’s reopening could be even more powerful than what we saw in Western economies. First, China abandoned its Covid policies all at once. The change is immediate rather than, for example, the year-long process in the U.S., which varied at the state level and made for an uneven recovery. Second, China’s lockdowns were much more severe and lasted longer. Online and e-commerce companies in China did not benefit during the pandemic to the same extent as their Western peers. Therefore, the negative impact of the reopening is likely to be less severe for Chinese e-commerce. Finally, the rapid reopening of the economy comes at a time when Chinese household savings are at a historic high — up nearly 100% over 2021 levels.

    Real estate backstop. Another potential tailwind for equity markets in China is the government’s decision to reverse course on its real estate market policies. Several years ago, Xi famously said “Housing is for living in, not for speculation,” in reference to speculative buying in the property market. As China’s real estate debt crisis worsened, the government introduced its “three red lines” policy in 2020. The policy restricted the amount of new borrowing by property developers. This, combined with a difficult macroeconomic environment, resulted in high-profile bankruptcies, and many private developers were priced for default. However, in addition to cutting mortgage rates and rolling back home purchase restrictions, People’s Bank of China issued a 16-point measure in November 2022 to support liquidity of higher-quality developers. Such measures should provide a much-needed boost to China’s property sector, which represents a significant portion of the economy.

    A break from tech regulatory risk. Beginning in late 2020, some of China’s largest technology companies experienced unprecedented intervention from the Chinese government as it sought to reduce the influence these companies have over users, gig economy workers, and mom-and-pop businesses. Deep regulatory actions led to a sharp, indiscriminate sell-off across the entire Chinese tech stock landscape. This regulatory risk, which tends to come in waves in China, appears to have stopped for now. With many investors still avoiding the sector and tech stock valuations at all-time lows, we believe this presents attractive opportunities.

    We believe, for several reasons, that the bear case for China may be off the table for now.

    Tactical positioning

    The outlook for China’s GDP growth and earnings has improved significantly over the past four months. In our portfolios, we have tactically added to our China exposure, and are equal weight to the benchmark MSCI Emerging Markets Equity Index. Our additions to the portfolio are based on increased consumption in China after three years of strict lockdowns. We are also focused on areas of growth that are aligned with the government’s goals. Two examples are Li-Ning, a sportswear and sports equipment company, and Huazhu Hotels Group, a developer and manager of more than 8,000 hotels. In our view, these local brands are more leveraged to the domestic consumption recovery story and thus are more immune to geopolitical risks. Also, even before the pandemic, these businesses were well positioned to be key beneficiaries of long-term structural growth.

    Positive outlook for EM equities overall

    In addition to our tactically more bullish positioning in China, we remain optimistic about EM equities overall. Valuations remain compelling, in our view, and we expect the U.S. dollar to continue to weaken, which is often beneficial for EM equity performance. We have overweight positioning in India and Indonesia, as we believe structural drivers will insulate their economies in the event of a global recession.

    link to Putnam Emerging Markets Equity strategy


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