Navigating Volatility and Identifying Long-Term Opportunities in Chinese Equities By: Invesco Distributors

2020 and the decade beyond was supposed to be “the decade” for emerging markets after 10 years of underperformance relative to the developed world. While EM was off to a promising start, the COVID-19 pandemic put much of the world on hold in 2020. Over the last 12 months, regulatory anxieties in China have risen at a time when COVID-19 continues to inhibit a recovery in many developing countries that have not been able to access vaccinations or vaccinate critical share of their populations. While COVID-19 flareups persist in major emerging market economies, the increasing proliferation of vaccines globally has resulted in a return to normalcy for many countries. In Emerging Markets economic recovery is underway in many major markets. Despite some of the near term challenges, we do believe that this asset class can offer many opportunities for investors. We wanted to take the opportunity to explore China more specifically given the recent headlines and volatility in the market.

China has been – and we believe will continue to be – one of the single largest narratives in the emerging world.Over the last 12 months, we have witnessed an acceleration of sharp-speared regulatory interventions across sectors, which has blind-sided investors and untethered confidence in stocks, particularly Chinese American depositary receipt (ADR) listings. While many investors have dismissed the long-term investment opportunity within China, we believe there are a number of meaningful long-term investment opportunities. Equally as important, we believe investors should better understand the layers behind the regulatory changes and the motivations behind these changes so they can better identify those opportunities.

The first set of questions investors should be exploring relate to what is going on with what investors view as chaotic interventions. These questions focus on such as the immediate implications of the regulations on companies, the objectives of those broader policy goals and existential changes in policy behavior. In short – investors need to explore the ‘what’ and the ‘why.” Over the last 12 months China has proposed new regulations (the ‘what’) around anti-competitive behavior, fintech, education, data security, work protections and content restrictions. We have seen a violent initial reaction to these regulations as investors grapple with understanding first derivative implications to company valuations. However, if investors consider the ‘why’, the goals of the regulations become clearer. The first two seem reasonably clear – inequality and development of China’s capital markets. Following three decades of unbridled growth, policymakers in China — like much of the rest of the world — are seeking to shift the balance of increasingly asymmetric distribution of returns between capital and labor. There is a well-articulated attempt to improve social mobility, to create greater equality of opportunity via fair competition and regulation of monopolistic practices. We also think a motivator of at least some of the actions is perhaps the desire to foster development of China’s capital market by restricting overseas listings and promote Hong Kong as the preferred“offshore, but domestic” capital market.

These ‘whys' are broadly aligned with bigger policy goals articulated at the 19th Party Congress in 2017, during which“Xi Jinping thought” was enshrined, with its emphasis on “socialism with Chinese characteristics.” The three broad goals that we believe are relevant here deal with the negative externalities associated with China’s breakneck growth over the past few decades – environment, equality and geopolitics. Through these industrial policies China is seeking to make enormous strides to improve environmental sustainability, enhance equality and opportunity, remediate perceived external dependencies (most notably its dependence on oil, semiconductors, and the US dollar as the dominant currency for its trade).

Despite the recent challenges, we believe considerable opportunities for investors still exist in China. Those opportunities exist in a few buckets. Alongside this broader policy imperative of “inclusive growth,” we see continued opportunities in the consumer sector especially in structural growth industries like hotels, restaurants, and luxury goods. In our view, these are thriving industries prone to consolidation by leading players. Second, we believe there are significant long-tailed opportunities in China’s life sciences and health care industries. These also fit within China’s policy priorities to improve inclusive growth, redress significant unmet medical needs across the population, and build global leadership in next-generation segments of drug innovation and manufacturing. There are, in our view, many parallels between the life science industry in China today and where China’s dominant internet companies were a decade ago. We also believe we will see a number of companies emerge as leading global players across the life sciences industry over the next decade. Finally, we do not dismiss the prospects that many of China’s leading tech companies can find new balance and prove to be excellent investment opportunities here, after big declines. A few months back, many leading Chinese businesses were perceived to have a bright future, with a profitable earnings track ahead of them. Many of these stocks are now down 30% to 50% - has the earnings power of these tech platforms reduced by 30% to 50%? If not, how much has sentiment played a role in this market direction? When the question is framed like that, we see a lot of hope and indeed opportunities. The second question specific to China tech is — what good could come out of regulation? Over the last decade, we have seen several instances of destructive competition with profitability under competitive attack thanks to subsidies, price wars, and misdirected investments. We have seen prolonged battles for market share that seemed illogical, especially in markets where there were just a few players left — as with fintech, food delivery, and parts of logistics. In the future of China tech, we sense some sanity. Under regulatory pressure, some rationality could come back in the way these economic decisions are taken. As investors, we might see very positive consequences in terms of long-term profitability, steady earnings growth, and a decline in these periodic adrenaline rushes China tech has seen in the past. These could lead to positive investment outcomes.

Important Information

Foreign investments may be volatile and involve additional expenses and special risks, including currency fluctuations, foreign taxes, regulatory and geopolitical risks. Investments in securities of growth companies may be volatile. Emerging and developing market investments may be especially volatile. Eurozone investments may be subject to volatility and liquidity issues. Investing significantly in a particular region, industry, sector or issuer may increase volatility and risk.

The opinions expressed are those of the author as of November 1, 2021 are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial advisor/financial consultant before making any investment decisions. Invesco does not provide tax advice.The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

It should not be assumed that an investment in the sectors and countries identified above was or will be profitable. Actual holdings may vary for each pooled vehicle and client and there is no guarantee that a particular client’s account will hold any or all the sectors and countries listed. Allocations are subject to change. The portfolio information shown is derived from are presentative account deemed to appropriately represent this management style. Each investor’s portfolio is individually managed and may vary from the information shown. Past performance is no guarantee of future results.

All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This is not to be construed as an offer to buy or sell any financial instruments and should not be relied upon as the sole factor in an investment making decision. As with all investments there are associated inherent risks. This should not be considered are commendation to purchase any investment product. This does not constitute a recommendation of any investment strategy for a particular investor. Investors should consult a financial professional before making any investment decisions if they are uncertain whether an investment is suitable for them. Please obtain and review all financial material carefully before investing.

All data provided by Invesco unless otherwise noted. Invesco Distributors, Inc. is the US distributor for Invesco Ltd.’s retail products and collective trust funds. Invesco Advisers, Inc. and other affiliated investment advisers mentioned provide investment advisory services and do not sell securities. Invesco Unit Investment Trusts are distributed by the sponsor, Invesco Capital Markets, Inc., and broker-dealers including Invesco Distributors, Inc. Each entity is an indirect, wholly owned subsidiary of Invesco Ltd.

Invesco Distributors
Sign up for our Newsletter

More Articles From This Issue

Sign up for our Newsletter