China’s economic struggles, in part, stem from large and prolonged property price declines and a collapse in transactional liquidity.
A raft of easing measures has been rolled out by various Chinese government agencies, but many details have not been disclosed.
If China can accomplish its policy goals, the results could be very positive for the economy. But this is not why we own our companies.
China stocks, which represent 28% of the MSCI Emerging Markets Index (and 21% of the Invesco Developing Markets Fund)1, have returned from an extended period of dormancy to the center of attention for investors in developing markets. After three rather miserable years (-16% annualized returns June 2021-June 2024), the MSCI China Index surged 22% in the last week of September2 after policymakers stepped in with renewed vigor to address some of the causes of China’s economic struggles.
Below we discuss why China’s nominal economic growth has decelerated spectacularly over the past three years, how these remarkable policy announcements are intended to help, and why our bullish stance on our China holdings transcends these announcements.
In 2020, China announced its “three red lines” policy, which set limits on financial leverage and effectively bankrupted most private sector property developers. The property sector, which accounted for more than a quarter of gross domestic product (GDP) in the decade between 2011 and 20213, went into a free fall. Property starts are down 65% since peak levels in 2021, while property sales are down 50%.4
China, with 50% to 60% of household wealth concentrated in property for the past 20 years5, was particularly susceptible to large and prolonged property price declines and a collapse in transactional liquidity. The wealth shock and parallel stress related to employment and incomes have, unsurprisingly, led households to increase financial savings, resulting in a radical domestic consumption slowdown. This, in turn, led to a huge increase in cash and bank deposits, which are well north of $20 trillion — almost 110% of GDP.6
Growth has also been hit by local government fiscal stress, with revenues highly levered to land sales. Following 15 years of boom-bust local government stimulus and debt expansion, local government spending has been in retreat.
The diagnosis of the problem and the prescription for stimulating growth through consumption seems to be accurate. The goal is a Keynesian push, albeit belated, to stop deflation. Policymakers have clearly articulated aspirations to underwrite and stabilize the property sector and to unclog the interconnected nexus of local government fiscal and property market stresses (including dealing with off-balance-sheet local government debt), perhaps Hamilton style.
A raft of easing measures has been rolled out by various government agencies, including monetary measures (policy rate cut, lower reserve requirements) and credit policies (proactive reduction in outstanding mortgage rates and easing of restrictions on home purchases/mortgages). There also appears to be the realization that supportive capital market policies may be part of the solution to repairing household balance sheets and addressing the long-term issue of excess savings in China.
These announcements appear to be well-timed, as recent USD policy rate cuts are supportive of the Renminbi (RMB). However, the details, including the magnitude and focus of fiscal stimulus, have not been disclosed and await legislative approvals, likely in the next few weeks. Market volatility of recent days reflects uncertainty about these details, which clearly matter.
While we disclaim any particular insight into China policymaking at this stage, our hunch is that this is truly a remarkable shift in policy direction. Like the sudden reversal around COVID restrictions, this is another 180-degree shift. We suspect that policymakers will deliver the sustained fiscal expansion necessary to accomplish their well-articulated goals.
Although markets are focused on the magnitude of fiscal stimulus, we would like to see efforts to both reduce cyclical stress and provide greater institutional capacity for structural growth. China needs to change the tired economic model of the past in order to reap the enormous potential growth it has as a continental-sized, developing economy. If they manage to accomplish this, the results could be very positive for the economy, but this is not why we own our companies.
Despite our underweight in China, we are very bullish on the Invesco Developing Markets Fund’s China holdings. We have structurally attractive companies with durable growth, sustainable advantage, and significantly improved returns to shareholders, and we believe valuations remain attractive (even after significant recent gains). Our investments in H World, Tencent, Meituan, and AIA8 are in companies with attractive structural growth, in markets where competitive discipline has improved materially, and where boards are returning historically high levels of cash to shareholders through large buybacks and rising dividends. We have also in recent months expanded our core investments in China to Alibaba9, a company that is in the process of a historic improvement in capital allocation and is returning its massive cash pile to shareholders at record levels.
Source: FactSet: As of 9/30/2024
Source: Bloomberg: As of 9/30/2024
Source: National Bureau of Statistics (NBS): 2023 Annual Report
Source: (NBS): July 2024 (Starts measured by volumes and sales measured by sqm volumes)
Source: People’s Bank of China (PBoC) Survey: 2019-2023
Source: (PBoC): September 2024
Source: (NBS): 2023 Annual Report
Source: As of 9/30/2024, the Invesco Developing Markets Fund held 5.8%, 5.1%, 3.1%, 2.7% and 1.2% in Tencent, H World, Meituan, Alibaba and AIA, respectively. Holdings are subject to change and are not buy/sell recommendations.
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Important information
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All investing involves risk, including the risk of loss.
Past performance does not guarantee future results.
Investments cannot be made directly in an index.
This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial professional before making any investment decisions.
Investments in companies located or operating in Greater China are subject to the following risks: nationalization, expropriation, or confiscation of property, difficulty in obtaining and/or enforcing judgments, alteration or discontinuation of economic reforms, military conflicts, and China’s dependency on the economies of other Asian countries, many of which are developing countries.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
Investing in securities of Chinese companies involves additional risks, including, but not limited to: the economy of China differs, often unfavorably, from the U.S. economy in such respects as structure, general development, government involvement, wealth distribution, rate of inflation, growth rate, allocation of resources and capital reinvestment, among others; the central government has historically exercised substantial control over virtually every sector of the Chinese economy through administrative regulation and/or state ownership; and actions of the Chinese central and local government authorities continue to have a substantial effect on economic conditions in China.
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Environmental, Social and Governance (ESG) considerations may vary across investments and issuers, and not every ESG factor may be identified or evaluated for investment. The Fund will not be solely based on ESG considerations; therefore, issuers may not be considered ESG-focused companies. ESG factors may affect the Fund’s exposure to certain companies or industries and may not work as intended. The Fund may underperform other funds that do not assess ESG factors or that use a different methodology to identify and/or incorporate ESG factors. ESG is not a uniformly defined characteristic and as a result, information used by the Fund to evaluate such factors may not be readily available, complete or accurate, and may vary across providers and issuers. There is no guarantee that ESG considerations will enhance Fund performance.
The current account records a nation’s transactions with the rest of the world. A positive current account balance indicates that the nation is a net lender to the rest of the world, while a negative current account balance indicates that it is a net borrower.
Deflation is a decrease in the price level of goods and services.
Monetary easing refers to the lowering of interest rates and deposit ratios by central banks.
Financial leverage refers to the use of debt to acquire additional assets.
Gross domestic product (GDP) is a broad indicator of a region’s economic activity, measuring the monetary value of all the finished goods and services produced in that region over a specified period of time.
Leverage measures a company’s total debt relative to the company’s book value.
A policy rate is the rate used by central banks to implement or signal their monetary policy stance.
The MSCI China Index captures large- and mid-cap representation across China H shares, B shares, Red chips, P chips, and foreign listings (e.g., ADRs).
The MSCI Emerging Markets Index captures large- and mid-cap representation in emerging market (EM) countries.
In general, stock values fluctuate, sometimes widely, in response to activities specific to the company as well as general market, economic and political conditions.
The Fund may hold illiquid securities that it may be unable to sell at the preferred time or price and could lose its entire investment in such securities.
The opinions referenced above are those of the author as of Oct. 18, 2024. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.
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