Talking Heads – Global emerging markets: adjusting to slower Chinese growth

This is an audio transcript of the Talking Heads podcast episode: Global emerging markets – adjusting to slower Chinese growth

Andrew Craig: Hello and welcome to the BNP Paribas Asset Management Talking Heads podcast. Every week, Talking Heads will bring you in-depth insights and analysis through the lens of sustainability on the topics that really matter to investors. In this episode, we’ll be discussing Asian and global emerging market equities. I’m Andy Craig, Co-head of the Investment Insights Centre, and I’m delighted to be joined today by Zhikai Chen, Head of Asian and Global Emerging Market Equities in our Hong Kong office. Welcome, Zhikai.

Zhikai Chen: Thank you, it’s a pleasure to be here.

AC: Over the last year, we’ve had a situation in China which has weighed heavily on markets, with Chinese consumers traumatised, a property sector in disarray and the authorities appearing somewhat slow in terms of stimulus or policy measures to counter these issues. When we think of Asian equities, there is a lot of attention on the weakness in China. What’s your take on what’s going on?

ZC: At the beginning of the year, there was a lot of optimism about the Chinese economy, with the ending of the zero Covid measures and a wide expectation that Chinese consumers would – as we saw in other countries and economies – start ‘revenge spending’ after the lockdowns ended.

We did see that surge in the first quarter, but after that, all consumption measures and retail growth sank to single digits. Why so? We, the investment community, probably underestimated how much the wealth effect had impacted Chinese consumers.

The problems in the real estate system had been around for more than two years, since the Chinese authorities imposed their ‘three red lines’ policy to limit [property developers’] debt levels. This meant these companies could no longer raise the liquidity they needed, yet their model depended on liquidity to keep projects going. Projects stopped rapidly and some large companies ran into trouble.

That impacted the secondary market as many households saw neighbourhood prices falling, which led to a pullback in consumers’ exuberance and is probably one reason why there have been question marks over China’s growth prospects this year.

AC: There is the perception among the investment community that the Chinese authorities have the resources to do much more to stimulate the economy, but there seems to be a misalignment between what the market expects and what Beijing is delivering. How do you see things playing out in the coming months?

ZC: That is something that has puzzled me for most of this year as well. The investment community believes Beijing needs a certain level of growth to maintain social stability and the social compact with its citizens. The central government has low indebtedness and could do a lot more if it chose to.

We saw the willingness to do that in the global financial crisis of 2008/09 and also in 2015, when Beijing intervened to start a significant shantytown rebuild in China. So why not this time?

I think the investment community’s assumption of the required rate of economic growth is perhaps higher than the political leaders see it.

That may be why the authorities took some steps to stimulate the economy, starting with the Politburo statement in July. That gave optimism that there would be aid for the real estate sector, but unfortunately, that has not been followed through.

They also transferred another RMB 1 trillion of financing to allow some local governments to refinance their local government financing vehicles. They budgeted another trillion for this as well. So that is one area where they have ‘put their money where their mouth is’ to prevent any further spread of a systemic issue.

Overall, though, my sense is that they are comfortable in terms of how the economy is slowing and they believe it’s manageable. The anxiety for our investment committee is that we think they need slightly higher economic growth to sustain the social compact.

AC: Do you have any sense of how long it might take before the authorities implement measures that would be more in line with what the market expects?

ZC: We have six to seven weeks before the end of the year, so any ‘big bang’ in terms of fiscal spending is unlikely to materialise this year or even in the first quarter of next year.

My sense is that we would need to see an acceleration in the slowdown of China’s economy to persuade Beijing that it needs to step up the stimulus spending further. Given the data and the policy response we have seen so far, it’s quite clear that the authorities are not at a point where they believe they need to introduce any big stimulus.

AC: If we look to 2024 and at the other economies in Asia, where do you see potential opportunities?

ZC: One of the positive surprises this year has been the recovery in the hardware information technology sector, particularly semiconductors. There are a couple of drivers.

The excessive inventory that was built up over 2022 is finally working itself through in the various subsectors, for example, DRAM (dynamic random access memory) or NAND Flash. We have had positive signals from major electronics players that they’re seeing this semiconductor inventory cycle being resolved and that we will start to see a rebound in growth. That’s a fairly strong signal that the malaise we’ve seen in the IT sector is finally working itself through.

For Asian equities this year, we are probably down in absolute terms, mainly because Hong Kong and China equities are down. Across broader North Asia, South Korea and Taiwan have put in a decent performance this year, up by percentage points in the teens. This will probably continue.

There needs to be some readjustment for some of these stocks as the outlook for revenue and margins improves. For 2024, this is one area we feel positive about.

The other driver has been the evolution of the artificial intelligence theme. The improvements and revenue expectations for this segment had everyone scrambling to find investment exposure.

Asia – especially more developed Asia – is a key part of [the AI] supply chain and we’re going to see companies in Taiwan and South Korea being able to benefit. By now, this is a more rational investment consideration – selecting companies with bigger exposure to AI – than the blind rush we saw at the beginning.

AC: If we look globally at emerging market equities, what are the main points you would underline as important for investors with regard to the prospects in 2024?

ZC: In my view, emerging markets more broadly will unfortunately still be subject to global trends and rate influences. High interest rates in the US make it challenging for many emerging markets, mainly via the foreign currency angle.

I would say the good news for emerging markets going into 2024 – despite some volatility and uncertainty as to when the US Federal Reserve will finally start cutting rates – is that we are much closer to the endpoint of the rate cycle we were even nine months ago.

In many previously high-yielding economies, real rates are now high enough to start cutting rates even before the Fed. Much of the foreign direct investment flowing into some of these economies due to the fiscal stimulus in developed markets should help their economic growth in the coming year.

AC: Zhikai, thank you for joining us today.

ZC: A pleasure to be here. Thank you.