The China stock market faces challenges but there are still opportunities for investors

2022 was a tough year for investors in China. It took its place alongside technology and smaller companies among the worst performing sectors. Investor confidence slumped, with many worrying about an existential threat to China’s role in the global economy. Yet, for 2023, it is difficult to ignore the long-term growth potential of a developing country with 1.4bn people.

The average China/Greater China fund was down over 22% for the year to early December. This might not have been so bad, but Chinese equities had already been weak in 2021, leaving investors nursing significant cumulative losses. There were multiple contributing factors for this weakness. The first was that valuations had got very high, particularly in the country’s dominant technology sector. When the government outlined plans to impose greater regulation on the sector, it sent share prices tumbling.

There were also problems in the highly-indebted property sector. In 2021, the country’s second largest developer Evergrande . As the sector tumbled through 2022, several major companies sought bankruptcy protection. There were fears that the weakness in the sector would stall growth in the Chinese economy.

The country has also struggled to shake off Covid. Its strict zero-Covid policy has seen continued lockdowns and disruptions to manufacturing. Late November 2022 saw protests against the ongoing restrictions to freedoms. This has hurt economic growth. While the IMF was still predicting in October growth of 3.2% for 2022, that is some way below the 6-7% that investors have come to expect.

The final problem has been one of perception. In October’s party congress, Xi Jinping was confirmed as leader for a third term, consolidating his power. This worried investors who believe the move towards one-man rule after decades of power-sharing could reverse the country’s economic progress.

China has also shown itself to be a friend to Russia during the Ukraine crisis, which has inflamed an already tense relationship with the US. It is clear that the US will no longer be a fertile market for Chinese goods, and technology intellectual property will no longer be freely shared.

Some of the problems that have blighted Chinese markets are losing their sting. A rescue package for the property market has helped reverse a crackdown on lending to the sector. The 16-point plan allows banks to extend maturing loans, reduce deposit requirements and target other funding channels, such as credit markets. Shares in Chinese property companies rallied on the news.

Equally, despite the recent unrest, the situation on Covid appears to be broadly improving, with signs the long-running zero-Covid policy may be easing. The government is rolling out more effective vaccines and treatment options, including an inhalable vaccine. The country does not yet have its own mRNA vaccine but appears to be making progress towards one.

In the meantime, the economy appears to be resilient – industrial output remained strong, rising 5% in the year to October 2022. Retail sales dropped, but this reflected a period when Shanghai was under full lockdown. Fixed asset investment also continued to expand. 

The position of Xi Jinping is worrying. Concentration of power in a handful of individuals has seldom led to good outcomes. That said, for the time being, the government has been relatively sensible in its economic agenda. It has clamped down on those companies perceived to be doing social harm, such as social media groups, and sought to direct capital to ‘common prosperity’ targets, such as improving clean energy, raising efficiency and reducing emissions. There appears to be a recognition that the government needs to improve people’s lives to stay in power.

There are also areas of significant innovation. China has been a pioneer in social media but is also leading the way on some environmental technologies. Chinese robotics markets are growing, with installations rising.

Valuations were looking more appealing in the Chinese stock market towards the end of 2022 and it saw a recovery between the end of October and the end of November, with the MSCI China gaining around 25% from its lows.

Investors have a number of routes into China’s stock market. They can either invest through Hong Kong (‘H’ shares) or the domestic Chinese market (‘A’ shares). Most diversified China funds and investment trusts will hold a mix of both. Investment trusts specialising in China have recently been trading at significant discounts to their net asset value and this may represent an opportunity. If China’s stock market were to recover through 2023, investors could benefit from a narrowing of the discount and an uplift in the share price.

Using a general emerging market fund may also be an option. China has become a larger part of the global emerging market indices in recent years, and now makes up more than a quarter of the MSCI Emerging Market index. Investors in emerging markets funds are likely to have a significant chunk of their investment in China anyway. ETFs are also an option, with ETFs available on both the ‘A’ and ‘H’ shares market.

China has had a tough period and investors may be disillusioned. The country’s political set-up may also give investors pause for thought. However, there are still opportunities to invest in China as the country grows, innovates and matures. It is leading the world in certain key sectors. It will continue to throw off opportunities and, after a period of significant weakness, prices are undemanding.

As you build and manage your portfolio, the Fineco platform offers the tools, resources and investment options to help you keep track of what’s happening in markets around the world, including in China and Hong Kong.