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China: cutting through the noise to seek out opportunities

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J.P. Morgan Asset Management

This is a sponsored article from J.P. Morgan Asset Management.

Our investment team shares their 2H 2022 outlook on China equities and structural themes.

Key takeaways:

  1. Further monetary and fiscal stimulus, and some easing in the regulatory environment are expected to support the economy and manage the risk of slowing growth.
  2. Active management remains crucial, and key potential secular growth opportunities continue to resonate well among investors looking to take advantage of undemanding valuations within China’s technology, consumer and renewables industries1.
  3. Taking an active, longer-term focus and bottom-up stock picking approach could help identify quality corporates, and capture opportunities in China’s equity markets.

There are reasons to be cautiously optimistic on China’s economic and market outlook in 2H 2022. The pandemic hit the economy hard in 2Q 2022, especially in consumption and the job market. This is prompting the government to step up fiscal support to revive economic growth.

China’s policymakers can take various actions to help meet their growth target

Source: J.P. Morgan Asset Management. For illustration purposes only.

Central bank policy is likely to be more supportive of growth, in contrast with other major central banks’ tightening bias. For this recovery to be sustainable, consumer and business confidence need to stay buoyant.

China’s economic rebound and additional stimulus should support earnings recovery. Its regulatory environment shifting from ‘framework setting’ to ‘enforcement’ could help reduce uncertainty. These are likely to facilitate a valuation re-rating in both onshore and offshore Chinese equities.

Three long term structural themes 1
We believe that the key secular growth opportunities remain unchanged in China’s technology, consumption and carbon neutrality sectors. These long-term trends are likely to reassert themselves as growth stabilises.

Provided to illustrate macro trends, not to be construed as offer, research or investment advice.

Source: “China’s Share of Global Chip Sales Now Surpasses Taiwan’s, Closing in on Europe’s and Japan’s”, Semiconductor Industry Association, 10.01.2022. Forecasts and estimates are indicative of macro trends, may or may not come to pass.
  1. Technology goes beyond smart phones and ecommerce
    Technology has gone beyond smart phones and eCommerce in China. Artificial intelligence and cloud computing are becoming a part of everyday life. Against the backdrop of geopolitical uncertainty and COVID-19 resurgence, China’s technology industry is embracing an inward economic pivot and is looking to make breakthroughs in core technologies to reduce its reliance on imported software and hardware.

    • Semiconductor and other hardware industries
      For example, semiconductor and other hardware industries have been benefitting from the government’s drive for import substitution, and the relentless trend towards digitalisation and the electrification of many industries is creating even more demand.

      Specifically, within the semiconductor industry, we are seeing some companies in China come of age where they are now able to produce semiconductors at lower costs and with better customer service than some of the international competitors.

      • Software and industrial automation
        Software companies are also benefitting from the digitalisation trend and the government’s support for the creation of domestic champions. Industrial automation is another area of structural growth as companies in China are increasingly concerned about labour supply and cost, because a ‘greying’ workforce and rising wages make workers more expensive.

Source: China Association of Automobile Manufacturers, data as of February 2022. Forecasts and estimates are indicative of macro trends, may or may not come to pass.
  1. Energy transition and carbon-neutrality
    Energy transition and carbon-neutrality are likely to remain one of the core investment themes given the growing focus from China’s government. We expect rising new energy vehicle (NEV) penetration, stricter emission standards and controls, and faster adoption of renewable energy to continue in the next few years. This could support revenue and earnings growth of related segments. Beyond electric vehicle (EV) manufacturers, the EV supply chain and renewables such as solar power supply chains, installation, and storage could present opportunities too.

Source: China Condiment Industrial Association, Euromonitor, as of January 2022. Forecasts and estimates are indicative of macro trends, may or may not come to pass.
  1. Consumption: the expanding middle class
    With the latest wave of the pandemic, China’s government has imposed strict lockdowns on major cities in recent months. While we have been cognizant of this risk, we do think this is a temporary phenomenon. Looking further forward, we continue to see brands benefiting from the longer term premiumisation trend as the growing middle class demands better and healthier products. In some areas, industry consolidation opportunities can compound growth for many years to come. Healthcare spending will also likely continue to increase, and we see opportunities in areas such as medical equipment and contract research organisations (CROs) & contract manufacturing organisations (CMOs).

Three near term areas of focus1
Given the changing regulatory landscape and sector dynamics, we are looking for opportunities at the stock level which may benefit from turnaround, either due to earnings recovery or potential valuation re-rating.

  1. Consumer staples:
    Amid sharply higher raw material prices, many consumer businesses suffered from a margin squeeze in 2021, leading to earnings downgrades. As anticipated, towards the end of 2021 we saw a number of industry leaders announcing price hikes, ranging from condiment manufacturers to other food and beverages makers. Over time, their strength in brand power could help quality companies to navigate the material-caused inflation and regain higher levels of profitability. We therefore look for signs of margin and earnings recovery in 2022, especially in mid/downstream businesses.
    1. Real estate:
      Within real estate there has been a notable U-turn in the industry landscape by giving developers improved access to onshore capital markets, loosening purchase restrictions locally, and delaying the expansion of a property tax pilot programme in 2022. Within this segment, we prefer to focus on names that come with their own structural drivers. Examples include property management companies, or consumer companies such as furniture or decorative paint which are consolidating the market and decoupling from the underlying property cycles.
      1. Internet:
        After more than a year of regulatory reset, the markets expect to see a policy focus to shift from announcement in 2021 to implementation in 2022. Again, an improvement in sentiment should be supportive of valuation re-rating. We believe the better quality internet companies remain robust operationally and financially, with long growth runways.

Overall, we are of the view that China’s policy seems to be shifting from de-risk to pro-growth. Valuations have adjusted along with the market and we see bottom-up stock picking opportunities for active managers. We are taking a longer term view, despite short term volatility, and consider selectively building positions from here.

Leveraging our on-the-ground research which focuses on company fundamentals, our investment professionals integrate bottom-up stock selection with structural themes, seeking to capture opportunities with long-term growth potential.

1. For illustrative purposes only based on current market conditions, subject to change from time to time. Not all investments are suitable for all investors. Exact allocation of portfolio depends on each individual’s circumstance and market conditions.

Provided to illustrate macro trends, not to be construed as offer, research or investment advice.

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J.P. Morgan Asset Management

This is a sponsored article from J.P. Morgan Asset Management.