Value managers routinely venture into markets that others are fleeing, and right now that makes China a natural destination.
Veteran bargain hunters admit China’s economic growth prospects look uncertain, and that policy makers may continue to stumble. But they calculate that Beijing will keep trying to stabilize the economy—enough to create a tactical opportunity in pockets of the market.
Investors have fled China as the recovery following three years of strict Covid restrictions, erratic policy steps and crackdown on its property market along with national champions like Internet giant Alibaba Group Holding (ticker: BABA) rattled confidence—among households, businesses and investors.
With the U.S. and China entering an even more tense relationship, many money managers have reined in their allocations to China and rolled out emerging markets ex-China funds for skittish clients.
But for some emerging market veterans familiar with navigating erratic policy makers in developing markets, the cheap valuations in parts of the Chinese stock market are a draw. Arjun Divecha, founder of GMO Emerging Markets Equity, is still cautious about China but has become less worried about the country’s sluggish recovery from Covid.
“That normalization of demand will happen, and there’s some evidence it is starting to happen if you look at car sales,” he says. “The government has been slow to reflate the economy for good reasons [due to its debt concerns] but I do think they will eventually succeed.”
BCA Research analysts highlighted glimpses of stabilization in the economy, with China’s credit growth improving in August and deflationary pressures seen earlier in the summer easing, with consumer prices up 0.1% versus the earlier year, better than the 0.3% decline in July.
The BCA analysts are looking for more proactive policy measures that will create significant economic improvement before becoming less bearish and rethinking their underweight recommendation to clients for Chinese assets.
But Louis Lau, director of investments at Brandes Investment Partners, tells Barron’s via email that he sees several potential avenues to improve investor sentiment, and he’s already looking for opportunities in internet stocks, life insurers, sportswear makers and the supply chain for solar.
For Henry Mallari-D’Auria, Ariel’s chief investment officer of global and emerging markets equities, the focus is on consumer-oriented companies he thinks will see faster growth in coming years, in part from Beijing’s efforts to revive confidence among households.
While Mallari-D’Auria sees some signs of stabilization in property prices from policy makers’ gradual efforts in recent weeks as laying the groundwork for repairing consumer sentiment. A couple of quarters of more stable property prices, as well as income growth and stronger auto sales would build the case consumer confidence is improving.
Such improvement will help the likes of Alibaba, which Mallari-D’Auria thinks can win in multiple ways. “There’s the cyclical rebound but the company is also restructuring itself,” he says.
Former Alibaba Chief Executive Daniel Zhang’s decision to step down two months after taking on the task of focusing on the company’s AliCloud unit creates a short-term cloud over the stock, which fell more than 4% on the news. The company said Zhang was leaving to run a new technology fund that AliGroup is expected to invest an initial $1 billion.
So far, Mallari-D’Auria doesn’t see the development changing the profit growth outlook for Alibaba’s core business nor does he see it changing the timetable for the unit’s spinoff.
A spinoff will help the valuation, but a near-term catalyst could come from signs confidence consumer spending is picking up. Recent cost-cutting at the company should also help. Though Mallari-D’Auria doesn’t expect valuations to return to pre-crackdown levels, he says investors can do well even if the stock bounces from its currently low valuation of nine times to 11 or 12 times earnings as confidence improves.
If consumers feel better about their prospects as Beijing delivers more stimulus, Mallari-D’Auria says automakers like Great Wall Motor (1210:Taiwan) could stand to benefit. Better auto sales would help but the company has a new sport-utility vehicle that allows them to take share at a higher profit per unit than in the past, and that should boost margins, he says.
While China may be growing at far slower pace of 3% to 5%, Divecha expects stronger growth in the areas Beijing is focused on, such as technology and in businesses related to the green transition, as its geopolitical tussle with the U.S. intensifies. The U.S. sanctions that have limited China’s access to critical technologies is spurring increased investment by Beijing into electric vehicles, semiconductor chips and computers to become less reliant on the world.
“It isn’t that growth has dropped off a cliff and will stay at zero forever or that something has fundamentally changed,” he says, noting long-term headwinds of a shrinking population and the country’s debt load. “You make more money when things go from truly awful to merely bad versus good to great.”
So far, that message hasn’t yet resonated with the market, with the iShares MSCI China exchange-traded fund (MCHI), down 5% so far this year. But that creates fertile shopping for patient bargain hunters looking to tap a near-term stabilization in the world’s second-largest economy.