Are China’s best days behind us?

It’s easy to forget that China only lifted its lockdown just over 18 months ago. Markets were pricing in expectations for the return of China to lift global markets and to return to strong growth itself.

Yet, here we stand today. China’s post-COVID recovery has been lacklustre at best and challenges in its property sector have had a ripple effect across the world where its developers have operated, including here in Australia.

It all begs the question, are China’s best days finally behind us?

Dr Joseph Lai, founder and Chief Investment Officer for Ox Capital, believes not, arguing that “it looks like the economy overall has bottomed, the valuation looks very attractive, and we think it’s an interesting time to look for future champions in that economy.”

Some of the promising signals Lai sees include:

• Growth in exports of 10% per annum
• Passenger car sales growing 9-10% per annum
• GDP likely to be 5% in real terms this year.

He’s so constructive that he is currently increasing his exposure to China.

In this episode of The Pitch, Lai discusses the key signals he sees in China, whether the property market is turning around, and his tips for approaching the Chinese market, noting that being selective is the key.

Please note this interview was recorded on Wednesday 19 June 2024.

Edited transcript

Should investors be worried about China’s sluggish recovery?

Post-COVID reopening, the recovery in China has been relatively lacklustre and I think we can put it down to two things.

One is that there was not the big consumer stimulus that was typical of almost all economies in the world – China didn’t do it. So that’s one. I guess the upshot is that they didn’t have any inflation problem at all.

The second is the big property market adjustment, which they have undertaken in the last three and a half years. The reality was the authorities thought the way to future prosperity for the economy or the country was by not building increasing amounts of apartments in the cities. They decided to deliberately deflate the property bubble, which has led to more sluggish economic growth. And that’s what is happening.

However, looking at the economy today, it looks like a lot of adjustment has already happened. Property prices depend on where it is. It has gone down about 15-30%. The amount of new property sales has probably gone down 60-70% from the peak and construction activities have gone back more than a decade relative to today. 

A lot of adjustment has happened and the government has turned to be more stimulatory in its actions. It looks like the economy overall has bottomed, the valuation looks very attractive and we think it’s an interesting time to look for future champions in that economy.

What are some of the promising signals that you’re seeing?

It’s interesting – despite what we hear, the economy is not as bad as it seems. For example, if you look at the GDP numbers. It is likely to grow slower but is likely to be around 5% in real terms this year and probably in the near future. If we look at retail sales, it is still in positive territory. We look at exports despite all the concern over supply chains since COVID. The reality is they actually have been growing exports around 10% a year recently.

If we look at consumer metrics like passenger car sales, it actually has been growing at up to 9-10% a year as well over recent years. They sell about 27 million passenger vehicles a year, which is by far the biggest car market in the world.

So, if you look at the overall picture, it’s not like the economy is collapsing by any means, but in fact, it is growing slower. We are seeing various activities travelling slower, but it’s going ok.

Touching back on the challenged property sector, are we starting to see a turnaround?

I suspect a lot of the adjustments have happened already, but it is not likely we’ll go back to the good old days of 3-4 years ago, because the pain has been had by the economy. It’s not in China’s interest to re-stimulate it to this bubbly scenario. 

The likely outcome is that, given so much adjustment has happened, there will be a level of stabilisation. This is more or less what we are seeing. I think that’s the overall picture. We believe that in certain markets, like in the more prosperous cities like Shanghai or Beijing or other cities, the supply has shrunk so much that in the coming 12-18 months, there will be some sort of shortage to a degree.

Do you see that as an opportunity for your portfolio?

I suspect that people are coming around to the idea that the property market is unlikely to be as vibrant as before. The reality is that, because of the contraction of that sector, it’s not such a big part of the economy anymore. Even if it slows a bit, it’s fine. If it rebounds, it’s nice but it is unlikely to be a driver for the economy.

There’s clearly been a lot of negativity towards the economy – some with good reason, but what we think is interesting is to look for the future champions in these economies. Remember the GFC where the whole US banking system blew up and the property market collapsed? That was the time to buy the best businesses in the United States and we believe this is a similar opportunity in China.

Which areas do you see as the biggest opportunities going forward?

We want to choose stocks that are the future of China, as opposed to the past. We also want to choose those sectors that are not against what authorities want in the future to reduce the risk of regulatory interference. And the third is that the valuation is very attractive.

These areas are sectors in the internet space, healthcare and technology. These are private sector businesses that are kicking goals, doing well domestically, some of which are travelling overseas and achieving a high level of success. They are remarkable enterprises. They are investing multi-billion dollars into research and development to climb the technological ladder so that they can outcompete their peers. Domestic business within China is extremely competitive – this is true market competition. There are very few oligopolies there, especially in new industries.

What they found is those who can do well in domestic China – if they can compete – if they go offshore, they can do very well. We are already seeing examples of that, even in Australia. Companies like BYD. The cars they sell outside of China are priced a few times higher than in China. It’s highly profitable for them to sell cars in other countries.

We are seeing companies like Pinduoduo/PDD Holdings (NASDAQ: PDD) start to roll out their business model to other markets in the world. It’s called Temu in Australia. The growth of that is amazing. Other businesses are doing that, which again is because of the hard work, entrepreneurialism, and relentless investment in research and development, which is enabling them to outcompete almost everyone else in the world.

What level of exposure to China do you currently have in your portfolios? Do you expect to adjust this in the coming 12 to 24 months?

When China was having a big slowdown two years ago, we were underweight on our China exposure. We’ve increased our exposure quite a lot. The market was very weak and we saw the opportunity. We have a really high level of valuation discipline for these great companies. When the valuations come off, we see it as an opportunity. We’ve already increased our weighting to China and whether we add more to that economy depends on whether we can identify new opportunities, which are the future champions at attractive valuations.

What's one thing you want investors to understand about China?

One thing that’s important to bear in mind is China is the world’s second-biggest economy. It’s undergone significant adjustments. However, the economy will likely continue to grow in the next three to five years. The level of wealth, the GDP per capita is still low at about $US12,000 per person, way below developed markets. So, the momentum for growth is still there.

To be perfectly frank, if one is a betting person, it is more likely that the economy or the GDP per capita would grow from $12,000 to $15,000/$16,000 in five years than going backwards. That’s the thing that underpins our optimism to these champion businesses in this economy. 

We don’t want to go to the good old days of just buying any bank or any property developer to access these opportunities. We want to be selective. The thing to remember is, that even though there’s a bit of concern over the economy, the long-term outlook is likely to be good. Then, be selective and choose the right businesses to own, especially now when the valuations are so attractive.

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