Jason Hollands

ACCORDING to the lunar calendar, Chinese New Year falls on February 10. The Chinese zodiac dictates that the new lunar year will be the Year of the Dragon. Those born in dragon years – the last of which was 2012 – are believed to possess the characteristics of being ambitious, confident, and reluctant to accept defeat.

These attributes will certainly be welcome if they are reflected in the performance of China’s stock markets over the coming year, as Chinese equities have endured a truly torrid run over the last three years. Since peaking in February 2021, the MSCI China Index has plunged 57% in total return terms (in USD).

Caution towards China has been fuelled by weaknesses in its economic model, which historically has been too reliant on debt-fuelled internal investment and exports. State crackdowns on technology companies and the education sector have also spooked investors while deterioration in China’s relationship with the West accelerated with the Covid crisis. Concerns have brewed about the authoritarian direction under President Xi.

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With China being the largest country in the MSCI Emerging Market Index, representing a quarter of it by market capitalisation, its poor performance has also dragged down the wider emerging market and Asian indices.

As recently as early 2020, when Covid caused a global healthcare and economic crisis, some commentators boldly predicted that the pandemic would even accelerate China’s path to become the world’s largest economy – arguing its swift and draconian response would provide it with an advantage over Western democracies squeamish about curtailing personal liberties.

This proved wrong, with China only finally ditching its extreme lockdown restrictions in December 2020 in the face of mounting social unrest and having inflicted severe damage to its economy.

Problems have continued to surface in China’s vast property sector. While inflation has been a post-pandemic problem across much of the globe, China is grappling with the opposite challenge: falling prices. Data this week showed consumer prices falling at their fastest rate in 15 years, underlining the dilemma facing the nation’s policymakers as they try to revive the economy, and global investors’ confidence in it.

Burned by the experience of supply-chain blockages during the pandemic when Chinese factories shut their doors, Western firms have also sought to diversify their manufacturing supply chains away from China, to lower-cost economies like India and Vietnam as well as closer to home, a trend that will continue to play out over years.

International investors have been pulling cash out of Chinese equities over the last year at breakneck speed. Data from The Investment Association reveals that funds in the China/Greater China sector have seen a pattern of outflows in every month since February 2023.

In recent days, Chinese shares have staged a dramatic fight-back as authorities have stepped in to try to arrest the market slump. Measures have been taken to clamp down on short-selling of Chinese shares – trades that bet on declines – and China’s sovereign wealth fund has been ordered to plough money into Chinese Exchange Traded Funds.

The news this week that Xi has replaced the head of the Chinese financial market regulator has stoked expectations that further measures to juice the Chinese stock market could be on their way.

For investors, a key question is whether this might be a turning point, even a buying opportunity or a temporary spike – a so-called “dead cat bounce” – before the downward trend reasserts itself. It is too early to say. Chinese shares are undeniably trading on historically very low valuations and it is not impossible that Chinese shares could prove a bit of a wildcard performer in 2024.

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From here on, China’s population is set to age, while the workforce shrinks dramatically. This has eerie parallels to the situation that Japan has found itself in since 2010, with one big difference: Japan had long before reached the status of a major developed economy. 

While there could be a near-term trading opportunity in Chinese equities if authorities follow through with further measures to kickstart ailing stock markets, there are still risks on the near horizon to consider. China’s relationship with the US – its biggest export market – remains under strain and a potential victory by Donald Trump in the presidential elections in November would see trade wars firmly back on the agenda.

For longer-term investors, China’s main rival for the emerging market crown – India – has a more convincing case for inclusion in a portfolio. Its demographic profile is compelling. It has a fast-growing population, which overtook China’s last year and made India the world’s most populous nation – and the average age is a youthful 28.

So, while there are undoubtedly selective opportunities in China, investors might consider broader Asian and emerging market funds and investment trusts with a meaningful exposure towards India rather than funds focused exclusively on Chinese shares. These including the likes of Pacific Assets Trust plc and the Aubrey Global Emerging Market Opportunities fund, respectively managed by Edinburgh-based firms Stewart Investors and Aubrey Capital.

Jason Hollands is managing director at wealth manager Evelyn Partners, which has offices in Glasgow, Edinburgh and Aberdeen