15 November 2021

2022 China Equities Outlook: Navigating Changing Tides

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2022 China Equities Outlook: Navigating Shifting Tides

China’s recent regulatory changes will set the tone for 2022, as the focus on sustainability becomes increasingly central to the Chinese economy. These actions have upturned sectors like education and online gaming and reined in the property sector — all aimed at addressing the main socioeconomic challenges facing Chinese society today. At the same time, China has announced measures to achieve its goal of peak carbon emissions by 2030, with implications for industrial energy use.

Navigating these changes may be the main challenge for investors in the short term against a global backdrop of rising inflation in the West and prevailing US-China tensions. That said, we continue to believe the long-term case for Chinese equities remain intact, particularly for investors with the patience and flexibility to position across the opportunity set.

Navigating China’s A-shares in volatile times

In the near term, China’s economic growth may see downward pressure amid slowing property sector activity and power shortages that have led to suspension of production in some regions. While there are reasons to be circumspect on corporate earnings prospects, we also see this environment as an opportunity to accumulate high-quality stocks, as valuations have become supportive in certain sectors. We note that small- and mid-cap companies in the A-share market have outperformed larger ones by about 20% as of September 2021. However, we need to be mindful of the earnings delivery capability of the smaller companies going forward. Meanwhile, we see potential to accumulate industry-leading large caps with solid fundamentals at cheaper valuations. Similarly, the recent correction in offshore China stocks has created some buying opportunities for specific companies, including tech companies.

While there is some uncertainty over whether more regulatory changes are in the offing, we believe the A-share market would carry a lower policy risk premium than offshore markets given that domestic investors typically have higher confidence on policy visibility.

Selectivity and ESG separate the disruptors from the disrupted  

While markets have focused on the selloff, we believe investors should not lose sight of a more important and long-lasting aspect of the regulatory shift: China’s elevation of sustainable business models and strong governance underscores the importance of ESG (environmental, social, and governance) factors in stock selection. Going forward, companies with better ESG performance are likely to be the disruptors rather than the disrupted.

China’s recent regulatory moves have been cast as a rebalancing of excesses in certain sectors that are contributing to the “three mountains” – housing, education, and health care – that can pose daunting challenges to young families. (For more on this topic, see our recent piece, “China’s ‘Three Mountains’ Spur Market-Moving Regulation”). Despite multiple steps the government has taken to loosen its one-child policy since 2014, the fertility rate is still near alarming low levels.

China’s Fertility Rate Is Well Below Replacement Level

China's Fertility Rate Is Well Below Replacement Level

Source: World Bank data, accessed 8 November 2021. For illustrative purposes only. We are not soliciting or recommending any action based on this material.

The pre-school population, which peaked in 2020, is expected to decline notably starting in 2021. The cost of housing and education are the two main reasons why couples are not having children, with spending on these items taking up more than a third of a typical Chinese family’s disposable income (see chart below). Not only do parents spend a lot of money to send their kids to good schools, but after-school tutoring has also become essential, with kids spending an average of six hours per week during the school term and 15 hours per week during the summer holiday on these activities.

Education and Housing Take Up More Than a Third of Chinese Families’ Disposable Income

Education and Housing Take Up More Than a Third of Chinese Families’ Disposable Income

Source: National Bureau of Statistics, accessed 8 November 2021. For illustrative purposes only. We are not soliciting or recommending any action based on this material.

Given the implications of demographic problems for China’s labor force, societal makeup, and economic vitality for decades to come, it is no surprise that the government has taken decisive steps to address them , even as it upends the business models of some companies.

In China, 2022 is heralded as a pivotal year– bookended by the Winter Olympics in February and later by the Communist Party’s Congress, an important twice-per-decade political gathering. All eyes will be on the latter for clues to Chinese leaders’ strategic direction. In the short term, investors should navigate the markets with greater selectivity to avoid sectors that are highly impacted by changing regulations and to position in line with the government’s sustainability thrust.

For more economic and asset class insights, see our full 2022 Investment Outlook: Opportunities in a Climate of Change.


Disclosure

Investing involves risk, including possible loss of principal. The information presented herein is for illustrative purposes only and should not be considered reflective of any particular security, strategy, or investment product. It represents a general assessment of the markets at a specific time and is not a guarantee of future performance results or market movement. This material does not constitute investment, financial, legal, tax, or other advice; investment research or a product of any research department; an offer to sell, or the solicitation of an offer to purchase any security or interest in a fund; or a recommendation for any investment product or strategy. PineBridge Investments is not soliciting or recommending any action based on information in this document. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author, may differ from the views or opinions expressed by other areas of PineBridge Investments, and are only for general informational purposes as of the date indicated. Views may be based on third-party data that has not been independently verified. PineBridge Investments does not approve of or endorse any re-publication or sharing of this material. You are solely responsible for deciding whether any investment product or strategy is appropriate for you based upon your investment goals, financial situation and tolerance for risk.

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