Imogen Harris
Assistant Fund Manager Premier Miton Global Smaller Companies Fund
For information purposes only. The views and opinions expressed here are those of the author at the time of writing and can change; they may not represent the views of Premier Miton and should not be taken as statements of fact, nor should they be relied upon for making investment decisions.
The year of the Rabbit
A folk tale told often is the story of how the animals within the Chinese zodiac were ordered. While there are many versions, one version goes that the Jade Emperor organised a race across a river, a race that would decide which animals would have a year named after them, and thereby be forever immortalised on the Chinese Zodiac.
The rabbit started by hopping along the riverbank, but when it tried to leap from stone to stone across the river, it slipped and fell in the water. Luckily, a log floated nearby, the rabbit grabbed on and floated down the river to finish in fourth. It is also said that the dragon – who came in fifth – gave the rabbit a helping hand by blowing the log across the river.
Could the Year of the Rabbit be a reflection of this journey across the river? A combination of an optimistic start, a more precarious and volatile trajectory, with some good fortune along the way.
The optimistic start: the end of zero-covid and a wall of pent-up demand
After it seemed like China’s zero-covid stance was here to stay following the 20th Party Congress in October, the policy was unexpectedly dismantled towards the end of the year. Starting with domestic restrictions being relaxed in November, it was announced that international quarantine rules would be removed from January 8th 2023.
Markets rallied on the news of the policy change with the MSCI China Index and the Shanghai Composite Index appreciating. It is easy to see why the anticipation of a country of 1.4bn people going back to pre-Covid levels of spending and manufacturing moved markets to this extent. Economic data also looks promising. The Purchasing Managers Index, a good indication of activity hit 54.2 in February, well in the expansionary zone. The Purchasing Managers’ Index is a survey-based indicator of business conditions, which includes individual measures of business output, a score of more than 50 indicates an expansion of the manufacturing sector, a score of less than 50 indicates a decline.
Positive progress, but watching out for slippery rocks in the river
A recovery certainly gives a tailwind to the Chinese economy amid the background of a potential global recession. So, what could these ‘slippery rocks’ manifest as?
Revenge spending may be weaker than we think
Estimates suggest that Chinese consumers built up $2.6trillion of excess savings during the Zero-Covid policy. In the US and Western Europe, we saw a surge of ‘revenge spending’ in the initial phase of economic reopening and increased consumption led to higher corporate earnings, especially in consumer services. Indeed, Trip.com, the biggest Chinese online travel agency has appreciated 60% from the end of October to the end of February as an example.
The hazard with this first steppingstone, is that the spending patterns across China may not mirror the trajectory of US and Western Europe. Chinese New Year is accompanied by what is called ‘the biggest human annual migration,’ where families travel across China to reunite for celebrations. The last year this is occurred was the Year of the Pig in 2019. The end of the Zero Covid Policy and higher domestic movements naturally increased infection rates. Anecdotally, young people held ‘Covid parties,’ where they could catch and recover from Covid, in time for returning to see their elderly relatives for Chinese New Year. This had a lessening impact on consumption – in other words – you cannot spend in the shops if you are at home recovering from Covid.
The other key difference in the recovery trajectory may be in how these savings are viewed. Unlike in the US and the UK, where the populace received more direct support from the government in the form of stimulus checks and income from the furlough scheme, China had no comparable national ‘helicopter money’ payment. Even the terminology reveals the difference – in the US, household pay-outs were termed ‘stimulus checks,’ which implies that the purpose of the cash was to stimulate the economy, so to be spent. If savings are harder earned, as they arguably were in China, it is likely that they will also be harder spent.
Inflation may be more volatile than we think
2022 brought record-high levels of inflation across the US and Western Europe, with the US Consumer Price Index hitting a 40 year high of 9.1% in June. However, China may not be on the same post-covid inflationary path. In 2023 – the Year of the Reopening, China will not have to cope with certain components of the inflationary pressures that faced the US and Western Europe in 2022.
First, the spikes in oil and natural gas price seen in the first half of 2022 will most likely not be repeated to such an extent, as the oil price spike was primarily caused by the Russian invasion of Ukraine. Secondly, the supply chain disruption that originated in 2021, has been and will most likely continue to diminish. Domestic manufacturing will no longer be disrupted by covid-related shutdowns and international shipping rates have nearly reverted to pre-covid levels. In addition, the weakening dollar may have a deflationary impact as exporting economies (like China) import deflation when their own currencies appreciate.
Despite this, a complacent view on inflation may slip investors up. Inflation was initially labelled as ‘transitionary’ in the US and Western Europe, until it swiftly was not, and the Federal Reserve have hiked rates accordingly to combat inflation. Moreover, the expectation of a global recession has deflated the price of essential raw materials. As an illustration, the oil price tends to be a good indicator of the market expectations of a global recession: as of the end of February, the oil price was USD77.05 a barrel, 36% lower than the peak in June 2022. The counterpoint may be that if Chinese demand re-enters the ring, and the global recession is shallower than previously thought, we may see the dial on inflationary pressure start to creep back up. This means the Federal Reserve may have to keep rates ‘higher for longer.’
A bit of luck
As a manager of a global fund, we need to think globally. Often the companies that we own have international revenue sources. Even if a company is not listed or based in China, it may have a high exposure to China via their revenue or manufacturing base. China’s reopening certainly represents a potential growth opportunity: an opportunity for China itself, via its domestic market, but also for the surrounding Asian countries via the impact on any cross-border import/export economic activity.
Like the rabbit’s passage across the river, the power of Chinese consumption and industrialisation may be steppingstones, but also may be simultaneous pitfalls. Even mild improvements or declines in consumer sentiment could have a powerful multiplier effect. With a rising middle class, good educational standards and a recent track record in entrepreneurialism, China looks like an encouraging investment prospect over the long term. However, over the next year, China may need a bit of luck for a stable recovery to emerge.
