With the S&P 500 index officially entering bear market territory last week, many investors fear that there is still more selling to come as the Fed remains committed to its promise of bringing inflation down 'at all costs'. While it may not seem prudent to start buying the dip in US equities, investing in China could present opportunities for portfolio diversification and wealth appreciation as its macroeconomic situation improves amidst a fresh wave of economic lockdowns. Alongside inexpensive valuations, I am bullish on Chinese Internet names and believe a rally is highly probable given strengthening fundamentals.
Lockdowns and the Chinese economy
Last week, China announced a fresh set of lockdowns in major cities such as Shanghai and Beijing as it rushes to contain new Covid-19 outbreaks. The country had just emerged from the end of a painful COVID-19 lockdown that has lasted more than six weeks, heavily bruising China's economy. China's zero-covid policy has raised serious concerns about its 2022 GDP growth, with many analysts downgrading forecasts from 5.5% to just 4%. In response, the Chinese government has released a new policy package containing 33 stimulus measures in another effort to boost the economy in the wake of COVID-19 lockdowns.
Growth forecasts for China's GDP (Source: BOFIT)
Fiscal and monetary policies
Due to divergent Sino-US monetary policies, China is likely to use a combination of fiscal stimulus and Quantitative Easing (QE) to boost aggregate demand. The PBOC just announced that it was keeping the benchmark lending rate unchanged, underscoring strong recovery momentum buoyed by existing policies to bolster growth. According to the PBOC, China’s central bank, the one-year loan prime rate (LPR) remains steady at 3.70 percent, and the five-year rate at 4.45 percent in June. Chinese officials signaled their intention to keep interest rates on par with the US to prevent capital outflows and a depreciation of the Chinese Yuan. Instead, its preferred instrument, the Financial Stability Fund to inject financial liquidity and accelerate economic activity. The Financial Stability Fund is managed by Vice Premier Liu He and is directly funded by the PBOC.
China has cut its LPR to 3.70% as economic growth slows
Room for expansion
Unlike the US, China does not face the pressing headache of raging inflation as intermittent Covid lockdown has slowed economic activity and dampened consumer spending. China's inflation rate in May was a meager 2.1%, compared to a whopping 8.6% in the US. As many countries grapple with the headache of balancing inflation and unemployment, China's low inflation reading gives it room to conduct more aggressive fiscal and monetary stimulus should growth expectations fall short of targets.
China's inflation rate remains very low compared to the US
Likewise, China's debt-to-GDP levels remain relatively low (66.8% of GDP) compared to many countries in Europe and the US which have debt-to-GDP levels of over 100%. Once again this means that China has the ability to borrow more to fund the expansion of its economy should growth slowdown. Given the low infation and debt levels, I believe that the Chinese economy is in a much healthier state than many developed nations and thus investing in the country by buying shares in Chinese companies may seem like a sensible choice for investors who are able to stomach short-term volatility and regulatory risks.
China govt debt-to-GDP (LHS) vs US govt debt-to-GDP (RHS)
Risks
As I just highlighted, the main risk which Chinese businesses, especially in the tech sector face is regulatory risk. The risk that the Chinese government may impose more stringent measures on tech companies was behind the selloff in Chinese tech equities in 2021. While the situation remains volatile, Beijing has appeared to shift towards a more supportive stance toward its tech companies as it attempts to revitalize the internet sector and prop up the Chinese economy, which is losing momentum amid the Russian invasion of Ukraine and the country's zero-COVID policy. Investors should continue to monitor and assess the situation closely before deciding to invest in these tech companies.
Some people may also highlight the risk of China's Zero Covid policy and the fact that it might lead to a slowdown in the Chinese economy. My contrarian take is that while cities are in lockdown, they actually rely on the services and distribution networks of tech giants such as Alibaba, JD and Meituan. Therefore, future lockdowns may positively impact these businesses as consumers spend a larger portion of their income on online services and e-commerce.
Valuation
Compared to the $Nasdaq 100 Trust(QQQ)$ , the $CSI China Internet ETF(KWEB)$ is trading at a lower average PE ratio of 24.28 vs the QQQ (31.92). I believe that comparing the economies across US and China, the KWEB should be trading at a premium compared to the US and not the other way round. Thus, I see a favourable risk-reward tradeoff when going long China (KWEB) and shorting the US (QQQ) for investors looking to hedge their equity positions.
The QQQ has outperformed the KWEB on a 1 year basis
A new economic cycle?
Since the first Covid-19 outbreak in China triggered a new economic cycle, Chinese tech equities have come a full 360 degrees and are currently trading at/below their 2020 prices. I believe that China's recent attempts to stimulate its economy coupled with its shift in stance towards tech companies could result in the creation of a new economic cycle with future growth to come. I am therefore bullish on the Chinese economy and would recommend investing in Chinese tech companies through the KWEB or $ISHARESHSTECH(03067)$ as tech companies generally lead the rally in a new economic cycle.
Disclaimer: This article is meant solely for informational and educational purposes and does not constitute investment advice. Perform your own due diligence before making any financial decisions.
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