'Chinese growth is in a rut, but there are signs things are shifting'

Given the size of China in emerging market indices and its importance as a trading partner, it is not surprising emerging markets have trailed their developed counterparts. 

Chinese economic growth is stuck in a rut, but there are positive signs that things are shifting.

China cannot be relied upon to do a lot of the heavy lifting for investors turning to emerging markets, as they have perhaps expected in the past.

China’s recent economic woes stem from a combination of its imploding real estate market that has triggered the failure of some of its largest listed property developers, the reduced levels of consumer activity this has helped to bring about and the renewed geopolitical tensions with the US. 

Given the power that the loosening of Covid-19 restrictions was due to unleash in 2023, investors will have been left disappointed and burnt as a result of the changing environment.

However, a recent shift in Chinese government policy has been more supportive and suggests the tide may be turning. Since the summer, we have seen China’s policymakers implement a RMB1tn (c. £112bn) two-year infrastructure spending spree. 

This comes on the back of support for the housing sector that includes additional financing for property developers alongside consumer-facing initiatives such as encouraging banks to reduce mortgage refinancing rates. 

This is important, as the property sector is a far more significant driver of China’s economy than those elsewhere. Around 44 per cent of China’s household wealth is held in fixed assets (by far the greatest part of which is real-estate holdings). This compares with only around 27 per cent of US household wealth. 

These measures could have a substantial impact on sentiment in China as they offer the potential for the real-estate sector, and by extension the consumer, to find their feet once again. 

China’s domestic issues are only one facet of the emerging market question, however. 

Easing tensions

It is always difficult to get an accurate read on geopolitical currents with meetings held behind closed doors, but Chinese/US tensions appear to be easing as the frequency of high-level talks between the two has grown. 

November announcements regarding reduced Chinese fentanyl production, the supply of which has greatly exacerbated the US opioid crisis, and joint statements on military matters also point to a thawing in relations. 

The strained relationship had been a major concern for global investors, so improvements here could also boost the market. On the flip side however, as the US presidential election ramps up in earnest, the looming possibility of another Donald Trump-led government could put things back on ice. 

Put simply, China cannot be relied upon to do a lot of the heavy lifting for investors turning to emerging markets, as they have perhaps expected in the past.

The picture away from China potentially looks bright for investors too. Chinese stocks account for 30 per cent of the emerging markets equity market, with India, Taiwan, Korea, Brazil and Saudi Arabia collectively accounting for 50 per cent.

All of these economies are expected to substantially outperform their developed market counterparts in the coming years, which translates into higher expected long-term earnings growth for emerging market stocks. 

This is supported by structural trends such as improving gross domestic product per capita and the broadening of financial markets.

Currently, emerging markets stock market prices are implying a limited expectation of economic growth, which is reflected by low valuations.

By comparing the P/E ratio we can compare value across markets. At the end of 2023, emerging markets equities were trading at 12 times earnings, making it one of the cheapest regions at a time when global developed equities were trading at more than 20-times earnings. 

Although history never repeats itself, the current valuation picture for emerging markets is much like it was throughout 2015 and 2016 – a period followed by two years of emerging markets substantially outperforming. 

However, while China’s status as the leading emerging market power is potentially decaying, it still holds a considerable sway on the outcomes of the broad collective.

So, while the outlook for emerging markets is improving, now is not the time to jump in with both feet. 

Most investors will need to see signs that China’s latest policy measures have the desired impacts on consumer sentiment and economic activity.

Similarly, while the long-term structural trends for local companies are appealing, investors also need to be mindful of nearer-term dynamics. 

So far, emerging market countries have seen less earnings growth than global equities and, until this improves, investors will be reluctant to increase their exposure to emerging markets.

All of which suggests that, while the case for greater emerging markets exposure is building, we are still at the very early stages of any recovery, awaiting more concrete evidence of improvement.

Sacha Chorley is portfolio manager at Quilter Investors