At the November meeting between President Xi and President Biden, the topics of discussion were eclectic, including fentanyl imports, military communications and the sending of pandas as envoys of friendships.
However, the details of the discussions were less important than the tacit admission from two of the most powerful countries in the world – that they need each other.
The meeting marked a notable departure from the inflammatory rhetoric that has characterised relations between the two countries over the past few years.
For investors, it may help shake the increasingly trenchant view that China is no place to invest. It may also help answer the question of whether Chinese markets could turn in the year ahead.
However, geopolitical tensions are only one of the factors that has weakened Chinese markets in the recent past.
There are two factors that could reverse its recent run of fortunes.While China’s well-publicised spat with the US has hurt a previously fruitful trading relationship – while also making investors nervous about whether their investments could be collateral damage – weak transparency, poor governance and government interference have also played a role.
Equally, investors might have overlooked all these factors had China repeated its exciting levels of pre-pandemic growth, but the Chinese economy has made a sluggish recovery from Covid-19.
More recently, it even tipped into deflation. Consumer prices fell 0.5 per cent in November, the steepest decline in three years, according to reports.
The country’s gross domestic product deflator – the broadest measure of prices – has now contracted for two consecutive quarters, according to a recent report in the Financial Times.
Deflation eats into real wages, corporate earnings and raises the real value of any debt.
None of this would appear to suggest an immediate turnaround for the Chinese economy, but aside from the recent panda diplomacy there are two factors that could reverse its recent run of fortunes.
The first is the potential for a "big bazooka" stimulus package from the Chinese government.
Policymakers have been wary of large stimulus measures, believing it helped create the debt bubble in its property sector.
Overcoming reluctance
However, investors have started to become increasingly hopeful the Chinese government will overcome its reluctance and announce new measures in the face of weakening economic growth.
In her latest fund commentary, Rebecca Jiang, manager of the JPMorgan China Growth & Income Trust, says there are emerging signs of action: “Approximately two months ago, China announced the most significant of the various incremental easing measures it has undertaken this year, namely lowering the downpayment requirements on mortgages.
"Although it is still too early to see definitively how this pans out, the initial evidence is that there are some signs of a stabilisation in property sales."
Investment managers report signs of capitulation in the market.She says economic data could start to improve from here. “The October purchasing managers’ index number came in below expectations, but it is likely that it was affected by the long holidays in the month.
"As the year-on-year economic data starts to factor in last year’s weak fourth quarter, like-for-like macroeconomic comparisons should become stronger into the end of this year.”
This would disrupt the now commonplace view that China is destined for structural stagflation.
There is also the question of whether Chinese markets are now just too cheap to ignore. The average fund in the Investment Association China/Greater China fund has dropped 20.7 per cent for the year to date, having dropped 16 per cent in 2022 and 10.7 per cent in 2021, data from FE Analytics states.
Admittedly, prices had probably got ahead of themselves prior to that point, but the MSCI China A Index now trades on a forward price-to-earnings ratio of 11.2x, compared with 16x for the MSCI ACWI.
It could, of course, get cheaper, but investment managers report signs of capitulation in the market. Companies that give mildly negative guidance have seen their share prices slump as investors throw in the towel, while good news is greeted with indifference.
Many international investors have turned their attention wholesale to India, which has a more appealing growth trajectory, but where stock markets are significantly more expensive.
Fertile source of innovation
Investment managers report that operationally, many Chinese companies are doing well, and it remains a fertile source of innovation in areas such as green energy and digitisation.
Martin Lau, manager of the FSSA All China fund, says he continues to focus on earnings and management rather than relying on economic growth, but also that the economy’s short-term challenges have not disrupted long-term trends, such as rising middle-class consumption and adoption of automation.
It is worth noting that there are still some fund managers who will not touch China.
Jason Pidcock, manager of the Jupiter Asian Income fund, has been an outspoken bear on Chinese markets, deterred by the levels of debt, problems in the property market, demographics, the national politics and its geopolitical position.
Bull markets seldom start when the environment looks rosy.His view is that there are other countries in the region where the risks are lower, where governments have a greater level of legitimacy and the rule of law is stronger.
There are also demographic headwinds for the country. The World Health Organisation now predicts that the population of over-60s will reach 28 per cent by 2040.
That is a worse profile than that of the UK and is consistent with a mature, low-growth economy rather than an ambitious, fast-growing emerging market.
There are still plenty of reasons not to invest in China.
However, bull markets seldom start when the environment looks rosy. Chinese markets have had a long run of weakness and there are a number of catalysts that could get investors interested again in the year ahead.
Darius McDermott is managing director of Chelsea Financial Services and FundCalibre
