Greater China equities: a resilient way forward

As the world continues to grapple with the coronavirus pandemic, Greater China equities have emerged relatively unscathed, outperforming emerging, developed, and regional markets in 2020.¹ Taiwan and China equities have gained 28% and 26% year to date, respectively, while Hong Kong posted double-digit returns. Better earnings growth visibility and diversification benefits have attracted inflows from both home and global investors, which have driven all three market indexes to all-time highs.²

Economic data also appears to support the performance of China equities. With effective measures in place to control the spread of COVID-19, China was the first major economy to recover from the pandemic, posting positive growth in the second and third quarters of 2020.³ The Caixin China General Manufacturing Purchasing Managers’ Index posted its seventh straight month of expansion since May. Corporate earnings have also been healthy, with the latest third-quarter data showing that most MSCI China index constituents have reported results that are better than expected or in line with expectations. Taiwan also recorded positive GDP growth in the third quarter, primarily on the back of robust demand for electronic exports.⁴

Throughout 2020, U.S.-China tensions lingered in the background. We believe that the relationship between the two countries could remain under pressure under a Biden administration. As such, we will adopt a wait-and-see approach in order to assess how the situation develops. However, we believe that the impact on Chinese equities should be well contained supported by an estimated earnings growth of 15% to 20% in 2021.⁵

Furthermore, China has already mapped out its response with the country’s 14^th five-year plan (2021 to 2025). The emphasis is now on generating growth through a dual circulation strategy led by internal circulation—in other words, moving toward a self-sufficient economy supported by homegrown innovation and domestic consumption. External circulation, as a supplementary driver, should increase China’s growth potential by allowing the domestic and foreign markets to lift one another. 

When combined, these factors make it probable that China’s growth can continue to show a clear and positive differential relative to the rest of the world. The nature of the postpandemic economy, although still fluid, is likely to amplify this gap.

With China having laid out a clear path toward an internally driven economy, opportunities are now arising in the technology and consumer sectors. On the technology front, more homegrown innovation in areas such as biotech is anticipated—these efforts will likely be bolstered by additional fiscal and policy support, such as tax incentives and low-cost funding, to boost local research and development initiatives and reduce reliance on imports. 

There are numerous opportunities along the tech supply chain, especially in areas that are crucial for achieving self-sufficiency. For instance, the upstream semiconductor equipment supply chain has a low level of localization, which has spurred targeted and supportive policies. Electric vehicle (EV) development is another attractive theme backed by both domestic demand and the local industry’s increasing presence in the global EV supply chain. A few domestic mid-end models tailored to Chinese consumers have been very well received, showcasing the capability of Chinese EV brands to adapt and cater to local needs and tastes. 

On the consumer spending front, there’s still plenty of unmet demand for lifestyle-related services. Increasing e-commerce penetration is another catalyst that’s seeing both product category expansion and wider age group adoption. Online fresh grocery services are one of the examples where growth can continue to be fueled by a shift to online shopping, product premiumization, and expansion to include the elder generation.

In both areas, investors should remain focused on the long-term fundamentals and seek to benefit from secular themes such as those stemming from consumption upgrades, innovation, and policy tailwinds. The opportunity set has also been expanded by the inclusion of mid-cap China A-shares into MSCI’s widely followed global indexes. This move offers unique investment opportunities not available in the offshore universe with a focus on under-researched ideas with stable growth outlooks. After all, we believe the asset class’s inclusion in global indexes has raised the profile of China equities as a whole. 

Within mainland China, the competitive advantages in the Greater Bay Area (GBA)—including ample policy support—can sustain strong and tangible long-term growth for the region and reward investors by way of corporate earnings. The central government pledged to deepen economic integration by enhancing intercity infrastructure, talent mobility, logistics, and investments within the GBA. Furthermore, the push for smart city implementation and management in the GBA, led by Shenzhen, should create opportunities in infrastructure, education, healthcare, and more. The investment case for the GBA can continue to benefit from cross-provincial initiatives in wealth management, insurance, and property connect program in the GBA region.⁶ Regional champions with their own growth dynamics will probably be best placed to exploit such opportunities. 

In Hong Kong, we believe that capital market liberalization will continue to provide investment opportunities for investors and attract further capital inflows. Since the introduction of new listing regimes in 2018, we’ve already seen a growing number of preprofit biotechnology companies listing on the market,⁷ some of which are already industry leaders. The relaxation of listing rules has also brought contract research organizations and contract development manufacturing organizations to the market, which has helped to fund their development. Investment choices could also be further enriched by the secondary listings of Chinese American Depository Receipts and companies with weighted voting rights structures. The market’s expanding connectivity and investor base can also be witnessed in the recent announcement of stock connect programs expansion to include biotech companies and stocks listed on the Shanghai Stock Exchange Science and Technology Innovation Board.

The COVID-19 outbreak doesn’t appear to have affected economic growth and corporate earnings in Taiwan last year. As we expect the U.S.-China tech conflict to continue, with U.S. policy continuing to focus on the protection of intellectual property and high-end technology, Taiwan equities should remain the key beneficiary against this macro backdrop. This explains why investors expect earnings per share to grow by 18% in 2021 from an already high base of 10% year-over-year growth in 2020.⁸

In 2021, we have a positive view of the technology sector, especially semiconductors. Taiwan is well positioned in the semiconductors industry, as it has the largest share of the global foundry market.⁹ The localization of the region’s technology supply chain coupled with Chinese companies’ move to reduce their reliance on U.S. suppliers should benefit the semiconductor supply chain, foundry industry, and integrated circuit design companies in Taiwan; meanwhile, the demand and development of high-speed transmission continues. We anticipate investment opportunities to emerge from a robust new product cycle in the tech sector with developments such as new generation wireless transmission for high-quality video and livestreaming.

In a similar vein to China equities, EV is an investment theme that we consider when looking at Taiwan equities. There are numerous upstream players with interesting opportunities in the EV market, especially power-related components.

Even before the pandemic, we saw a pullback in globalization trends. This has only been accelerated by recent events, which have combined with existing geopolitical tensions to push companies in the direction of shorter and more regional supply chains. The Greater China region is prepared for this shift. 

China’s differentiated growth expectations and capital market liberalization initiatives are likely to attract more foreign capital to renminbi-denominated assets or high-growth and well-managed Chinese enterprises. We believe investors are becoming more confident about the growth trajectory of China’s economy. With uncertainty remaining elevated, the search for sustainable growth may prevail; it’s vital to identify stock drivers through a bottom-up investment approach that seeks to uncover long-term fundamentals supported by secular themes such as consumption upgrades, innovation, and policy tailwinds. 

1 Bloomberg. The MSCI Zhong Hua Index posted a 21.38% gain, while the MSCI Emerging Market Index was up 10.51%, the MSCI World Index was up 11.72%, and the MSCI Asia-Pacific ex-Japan Index moved higher by 15.06%. Total returns are in U.S. dollars, as of November 30, 2020. Past performance does not guarantee future results. 2 Bloomberg. The MSCI Taiwan Index rose by 28.48%, the MSCI China Index was higher by 26.18%, and the MSCI Hong Kong Index was up by 12.18%. Total returns are in U.S. dollars, as of November 30, 2020. Past performance does not guarantee future results. 3 Bloomberg, December 7, 2020. China’s economy grew 3.2% and 4.9% year over year in Q2 2020 and Q3 2020, respectively. 4 Bloomberg, December 7, 2020. Taiwan’s economy grew 3.92% year over year in Q3 2020 after shrinking 0.58% in Q2 2020. 5 Manulife Investment Management, December 2020. 6 “CE attends meeting of Leading Group for Development of Guangdong-Hong Kong-Macao Greater Bay Area,” The Government of Hong Kong Special Administrative Region, November 6, 2019. 7 On April 30, 2018, Hong Kong Exchanges and Clearing Limited added new listing rules, under Chapter 18A, to permit listings of biotech issuers that do not meet any of the Main Board financial eligibility tests. As of September 30, 2020, there are 40 biotech companies listed in Hong Kong under Chapter 18A. 8 Manulife Investment Management, December 2020. 9 McKinsey, July 2019.