Accepting common prosperity: the latest in Chinese equity markets

ALMOST a year has passed since Ant Financial felt the wrath of China's regulatory hammer. What began as a seemingly isolated incident at that time has since morphed into a full-blown regulatory crackdown (still ongoing) by the Chinese government. This unfortunate twist of events has led to China being the worst performing major market in 2021 - a stark contrast to the optimism earlier this year. With regulatory risks notoriously hard to forecast and predict, what's next for Chinese equities?

Despite stellar growth, China has fallen behind its peers

The Chinese authorities' goals have long been clear: to transition the Chinese economy into a consumption-driven one instead of relying on exports and investments - all done without sacrificing economic growth.

Yet, progress in such efforts has been middling at best. In a study by the World Bank, China's final consumption expenditure as a percentage of GDP stands at 39 per cent and while it has risen much since 2010, it remains well short of its peers. By contrast, other economies, like Brazil (65 per cent), India (60 per cent), and the US (68 per cent) have significantly higher ratios, showing the enormity of the task at hand.

Having fallen way behind its peers, it then comes as no surprise the Chinese authorities have opted to intervene in the form of the recent regulatory measures. Their solution to this issue, as highlighted in the recent five-year plan, is twofold: to double down on increasing the proverbial pie through innovation, and ensure that the pie is more equitably distributed among its sizeable population.

While intervention by Chinese policymakers has been heavy-handed and clumsy at times (like the last-minute suspension of Ant Financial's IPO), it has been thematically consistent over time and not so much as anti-capitalism (or the CCP flexing its authority) that many media outlets have portrayed it to be.

Two prongs

Overall, many of its regulations can loosely be sorted into two categories: (i) anti-trust measures, (ii) social equality.

The first basket of regulations comprises the anti-trust measures, which account for most of the regulations announced thus far. These measures targeted at tech giants like Alibaba and Tencent were designed to reduce the monopoly power of these massive conglomerates.

There are strong parallels to be drawn here, with the concentration of power among the biggest tech companies in their respective markets - Alibaba and Tencent in China, the FAANG stocks in the US - are concerning to authorities on both sides. Many of these companies essentially run the marketplace that they operate in (eg Facebook in social media, Amazon in e-commerce). With regulations (particularly regarding virtual assets like data) still playing catchup, these companies have an overwhelmingly unfair advantage, ultimately stifling innovation and competition in the industry.

This is where China differs from the US - rather than waiting years, if not decades, debating among Congress - they have opted to intervene much earlier (eg outlawing "picking one from two").

The second basket is labelled social equality - structured around resolving the social issues that China has developed since opening its doors to outside world. Chinese citizens rarely feel assured regarding their access to necessities such as healthcare and housing, resulting in a higher propensity to save (45.8 per cent vs US' 19.0 per cent) to create a safety net to prevent financial disaster from any unforeseen circumstances.

Higher costs of living and raising children have resulted in plunging birth rates - exacerbating China's ageing population crisis, likely the main reason behind the recent clampdown of the for-profit after-school tutoring sector.

Looking forward, sectors part of the country's "Three Big Mountains" - education, healthcare, and housing - will continue to be at risk of further regulatory tightening, given their significant influence on the cost of living. By mitigating the costs of living and through regulation and changing the Hukou system, the Chinese government ultimately seeks to increase income stability and manage living costs, potentially encouraging citizens to increase their domestic spending.

That said, while intentions are clear, consistent, and good-natured, the path to achieving these goals will certainly not be a smooth one. The unprecedented regulatory measures have affected the fate of future growth and profitability of the affected companies.

The question remains: are Chinese equities uninvestable now?

The short answer - no.

From a longer-term perspective, China remains an attractive investment destination. Fundamentals remain strong, and ultimately, if successful, these regulatory changes will result in a healthier economy. The government's continued policy support in certain industries (which has naturally been overshadowed by the negative news) also suggests that the worst-case scenario - full-blown nationalisation - remains unlikely.

In fact, many areas receiving said support, such as semiconductors and 5G infrastructure, provide an excellent base and incentive for further innovation and technological development, especially if the unfair business practices of the monopolistic incumbents are properly managed. Coupled with its clean- up of the financial sector, this points to a more sustainable Chinese economy in the long run, and if the Chinese authorities successfully manage to unlock the latent spending ability of its population, one that does not have to give up stellar growth numbers to do so.

At the same time, the Chinese tech giants will likely still have a major role to play in an economy driven by domestic consumption. We believe that the crackdown should be taken at face value - and the measures implemented are intended to prevent anti-competitive behaviour, and to encourage innovation in the long term.

China's relatively benign investment landscape before the crackdown has lulled many investors into complacency. Many have forgotten that China equities have arguably always been a high-risk, high-reward play. While current valuations may be depressed, they are justified given the uncertainty regarding future regulatory risks (which in turn affects profit and growth).

Yet, with the long-term growth story intact (and arguably even stronger), for investors willing to stomach the risk, China remains a compelling investment opportunity. In particular, we see opportunities in the China A-share market, as they have lower index weights in areas sensitive to further regulation, specifically the beleaguered tech sector. Furthermore, The China A-share market also has a higher allocation to sectors outlined in China's five-year plan which are in line for continued government support - such as semiconductors, green energy, and autos - making it a more attractive proposition in the short term.

Finally, investors seeking exposure to China are encouraged to adopt an active approach, as in this unprecedented regulatory climate, there will certainly be inefficiencies and opportunities for fund managers with the expertise to take advantage of. Investors seeking exposure towards A shares can consider the Allianz China A Shares Fund, or those seeking a no-frills, balanced approach, can instead look at the JPMorgan Funds - China.

• The writer is the Unit Trust Analyst of the Research & Portfolio Management team at FSMOne.com. FSMOne.com is the Business-to-Consumer (B2C) division of iFAST Financial Pte Ltd, the Singapore subsidiary of SGX Mainboard-listed iFAST Corporation Ltd.