Over the past couple of years there has been a lot of talk about an allocation to China in a portfolio and recently that discussion has shifted to whether China is investable or not. Investors who ignore China do so at their peril, despite China becoming the largest economy for the rest of the century; be positioned differently from other developed market economies, thus offering diversification benefits; and being Australia’s largest trading partner.

Geopolitical concerns aside, Chinese equities, in our view, warrant an investment allocation. China is poised to join the rest of the reopened world, with Shanghai and other major cities emerging from COVID lockdowns. China’s central bank and government are supporting economic activity, as evidenced by a sharp increase in China’s credit impulse. The recent price action also presents a compelling reason for investors to consider an entry opportunity.

Figure 1: China’s biggest outbreak in more than two years appears to be under control

Figure 2: Air travel in China rebounded as cities reopened

Markets have reacted accordingly so far in the first seven days of the month, with “new economy” sectors rising more than 3%, as shown by the MarketGrader China New Economy Index. If the Chinese market reacts to the reopenings as it has in other markets, analysts expect a “strong rebound”. Global supply pressure is expected to ease as China reopens.

China’s stock market also reacts to positive policies

Chinese tech stocks surged last week as the latest batch of new game approvals from the government bolstered bets that the industry’s business outlook is improving.

China’s entertainment regulator on Tuesday approved licenses for 60 new games. Many investors see it as a sign of policy normalization in the wake of Beijing’s sweeping tech crackdown in 2021. CNEW holdings G-BITs, Kingnet, Shenzhen Shengxunda and 37 Interactive all rose more than 1.8% at the end of 2021. suite of endorsements, although none are directly involved in the 60 ratified games.

While the regulatory overhang for China and the Chinese tech sector will weigh on investors’ minds, China has been working for many years to open its stock market to foreign investors. Chinese authorities have worked hard to ensure that their A-share market is included in the MSCI and FTSE indices by meeting strict liquidity and accessibility criteria. We believe China A-shares are investable and the government will work with industry as policymakers boost the domestic economy.

The Importance of China

Overall, we remain bullish on China given the continent’s solid fundamentals. China will soon become the largest economy in the world and it will be China’s younger, urbanized population that will drive economic growth as the economy reopens.

A-share companies in the consumer, healthcare and technology sectors, which derive the bulk of their profits and revenues from the domestic market, appear to be well positioned to benefit from economic expansion and attempts of the government and the central bank to restart growth.

Looking back, one of the reasons investors diversify globally is to expose themselves to different business cycles than the ones domestically. With much of the developed world facing higher inflation, higher rates and governments with historically high debt levels, the Chinese economy has different economic fundamentals. China still has “dry powder” to boost its economy. Its central bank is working hard to create loans and growth in China, unlike much of the rest of the world, is expected to be positive in the second half of 2022.

Recently, US dollar and treasury yields have retreated from recent highs, which is good news for China as dollar strength is part of tightening conditions. The other positive factor for China and the rest of Asia is the improving credit impulse in China.

Figure 3: US Dollar Index and US 10-Year Yields (%) shot to highs in May

Figure 4: China’s rising credit impulse is good for Asian equities

The credit impulse is expected to continue to rise as China’s central bank urges lenders to increase lending. Over the past week, China’s central bank also said it would help lenders lower funding costs, as well as boost support for small businesses to stabilize the economy and jobs.

China is Australia’s largest trading partner, and while recent tensions between governments have grabbed the headlines, investors, regardless of their geopolitical views, who are not exposed to China, do. at their own risk, we think.

As a diversification and growth allocation, Chinese equities are, in our view, worth considering.

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