Dear Investors,
Let’s begin
We have understood that all the world will slow during 2023 and instead China’s economy should grow to 3.3%.
Moreover, if they’ll reopen their economy, what could be the real potential in 2023 for this country?
In this research we try to focus and answer to these questions, looking at their business and consumer confidence.
First thing above all, China is different vs other Major Economies. You see immediately with the chart below.
Inflation will begin to settle down, but it will settle at a higher number than we had pre-pandemic.
China is at a different stage of its business cycle compared with other economies and has room to ease policy as inflation remains low.
Investors will have to be more careful about what they are willing pay for future earnings and demands for profitability will come sooner.
All of this means that companies that can’t deliver earnings are more likely to see the market take down their valuation.
Is momentum for China?
With institutional holdings the lowest they have been in five years and valuations far below average, the risk/reward ratio for Chinese equities is favorable.
Rowe Price think that China’s property market has passed its peak and that long-term demand will probably be around half of the 2021 figure. However, a steep decline has already happened in 2022.
They don’t expect a V-shaped recovery in property but would expect to see a more stable situation in 2023.
Property is critical to China’s economy, contributing 10% to gross domestic product directly in 2021, or 25% if we include property-related supply chains.
While economic growth is slowing, at this point it doesn’t look like a recession in the U.S. will be very deep.
In contrast, economies in Europe are under significant stress, and a deeper recession there seems likely.
In emerging markets, we have seen economies under stress from China’s zero-COVID policies, the strong U.S. dollar and geopolitics.
China has a potential growth path
Rowe Price believe China is ready to move on from its zero-COVID policy and has embarked on the path to reopening, though the journey could be disruptive and chaotic, with possible zigzags on the way.
They also think the issue is likely to be largely behind us a couple of quarters from now, enabling China to return to its potential growth path.
Higher-frequency data should be the first to improve. In October, domestic flights were down 62% year on year, subway passenger revenues fell 20% year on year, and cinema takings were down 72% year on year.
China’s property market declined sharply in 2022, with sales down 33% from their peak in the fourth quarter of 2020 and housing new starts down 37.8% in the first 10 months of 2022.
Among China’s top 100 developers, over 90% are in a distressed situation, with bonds trading below 70 cents on the dollar.
However, post-Congress we have seen more coordinated efforts to support the sector.
China’s corporate profits
China’s corporate profits were suppressed in 2022 due to COVID and the property decline. However, we think they might have troughed.
Consensus is expecting China’s 2023 earnings per share (EPS) growth to accelerate to 10% from 2% in 2022.
On the other hand, global EPS growth (MSCI ACWI) is expected to decelerate from 7.5% in 2022 to 3.7% in 2023.
China is different vs other major economies
The stable inflation outlook provides a favorable backdrop for liquidity.
If we take the credit impulse as an indicator of China’s monetary cycle, the People’s Bank of China started to tighten in mid-2020 as the economy recovered strongly from the initial COVID lockdown.
That was part of the reason for the slowdown we have been seeing in the economy over the past 18 months.
The credit cycle turned at the beginning of 2022 when China began to loosen at the margin.
But monetary policy has not flowed through to the real economy because of the extended COVID lockdowns as well as the property market correction.
As both issues are expected to improve in 2023, the credit multiplier is likely to strengthen.
The one exception is China even for JP Morgan
As usual, China follows its own economic, policy and political cycles separate from the rest of the world.
2022 was the year of China’s hangover from its “zero COVID” policy, regulatory cycle and housing reform. Can 2023 be the year of its re-energizing?
In 3Q22, China’s economy re-accelerated with GDP rising 3.9% year-over-year versus 2Q’s meager 0.4% pace.
Looking ahead, the question for investors is how much speed China’s economy can pick up this quarter and in 2023.
Consumer and business confidence in China
In November, policymakers made three encouraging steps toward boosting confidence ahead:
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more targeted implementation of “zero COVID” policy, laying the groundwork for more substantial easing as the year progresses;
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liquidity and credit injections into the beleaguered real estate sector to provide a floor to its deceleration; and
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symbolic gestures toward the United States and other nations to lower the temperature of geopolitical uncertainty.
These steps in the right direction, if followed through, suggest some re-acceleration in China’s economic growth in 2023 (although a full return to normal will have to wait until 2024).
Focus on quality for success in equities
Columbia Threadneedle has made this important extract that I found very right and important which you find below.
Many investors think of valuation in terms of P/E multiples.
That metric is useful, but it’s not the only measure of a company’s value.
I think that free cash flow will be a more important metric because it will provide a good indication of how resilient a company may be in a high-inflation, weaker economic environment.
Cash on hand can also help deliver stock buybacks, which can support a company’s stock price. It will be a lot more expensive to fund buybacks through debt.
Because of this, free cash flow and dividend growth (rather than the absolute level of yield) are both metrics that may indicate a higher quality company.