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China domestic market rebound forges clearer path for A+H shares

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This is a sponsored article from Schroders.

Jack Lee, CFA,
China A-shares fund manager

Following the easing of Covid restrictions and the reopening of borders, economic activity in China, particularly consumption, has started to resume. While the global macroeconomic environment may cast a shadow over exports, China’s domestic demand remains robust. We expect 2023 to be a year of recovery for the Chinese economy. The market is on track to rebound from the troughs in 2022, and its GDP may grow by 6.2% in 2023, as assessed by our economics team.

While many may think of tourism, duty-free retail and hospitality as the hardest hit sectors due to the pandemic, these stocks actually have not seen steep falls, perhaps because negative factors had already been priced in early on. Instead, deeper losses were inflicted on advertising, cyclicals, wedding and banquet-related sectors, as well as consumer services (such as “baijiu” or Chinese liquor). As the Chinese economy reignites its momentum, these sectors may be back on the upward trajectory and drive gains for related A-shares and Hong Kong stocks.

Policy support across sectors benefits markets

The Chinese central government’s efforts to press ahead with its “common prosperity” policy and to expand its middle class should help shape a more resilient economic framework in the long run.

Since the fourth quarter of 2022, government authorities have started to lend support to the real estate market, with an aim to encourage the healthy development of the sector. Besides rolling out measures to ensure a timely delivery of presold homes, different governmental bodies have introduced coordinated policies to expand financing channels for stressed private developers in order to ease their financial pressure.

In addition, certain lower-tier cities have loosened their policies for home purchases by offering lower mortgage rates for first-time homebuyers, with an emphasis placed on meeting reasonable demand for housing. All these factors are favourable for the real estate market.

Even though there is still some way to go before investor confidence is fully restored and doubts remain over the long-term solvency of certain developers, we believe that supportive governmental policies can bolster the domestic real estate market, which is also an important means to a stable economy.

In response to the complex global macroeconomic environment, the Chinese government is making headway in strengthening its self-reliance in key strategic technological fields. The emphasis on “high-quality development” — as outlined in China’s 14th Five-Year Plan — is aligned with plans to develop high value-added industries.

One such example is the commercial large passenger aircraft industry that recently celebrated the delivery of China’s first domestically developed C919 passenger plane. The aircraft industry is expected to promote the development of a series of high value-added industries as China pushes ahead in high-end manufacturing.

China’s green energy and electric car industries look set to thrive thanks to concerted international efforts to address climate change risks. Currently, a number of Chinese listed companies in these industries are sector leaders globally, and they may offer opportunities for investors.

Cyclical sectors such as raw materials are also noteworthy on the back of a recovery in demand. Some companies in China’s technological innovation cycle may benefit from import substitution and, in some cases, may become global leaders in cutting-edge fields. However, technology and consumer electronics companies may remain fragile in the short run, due to weak consumer demand and a lack of significant new product launches. Therefore, we maintain our cautious view towards these sectors.

With weak global demand expected in 2023, export-oriented industries could be headed for another disappointing year.

Brace for potential risks and volatility

Risks of recession in Europe, geopolitical events, inflationary pressure, and the global energy crisis may add to the macroeconomic uncertainty. It is too early to tell how herd immunity will progress in China after the optimisation of its Covid-19 response. Investors should be prepared for market volatility stemming from these factors.

That said, we believe that with every risk comes opportunity. Experience has taught us that investing in A-shares during an economic downturn is not unlike playing mah-jong — that is, a quickly changing market may offer investors decent entry points. By digging deeper, by analysing company fundamentals — such as the operating status, capital cost and cash flow — investors may discover medium-sized, quality companies with great potential and capture structural growth opportunities.

Find out more about Schroders’ insights and capabilities on China investments here.

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Schroder Investment Management (Hong Kong) Limited
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This is a sponsored article from Schroders.

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