The Year Of The Rabbit May Well Require Investors To Be Flexible And Opportunistic
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Gong Xi Fa Cai! Franklin Templeton Emerging Markets Equity’s Chetan Sehgal shares some thoughts on investing in China in the Year of the Rabbit.
Feng Shui, the traditional Chinese practice of harnessing the flow of energy, indicates the Year of the Rabbit can pull people in different directions. For 2023, we may well see investors getting pulled in opposing directions, as hope and delivery could be at opposite ends of the year.
It is hoped Chinese consumption will recover
A surge or “revenge spending” in the initial phase of economic reopening, followed by a slower pace of growth, has characterized the pattern of post COVID-19 consumer spending in emerging markets. The slowdown was due in part to rising inflation and higher interest rates, which crimped real purchasing power.
China is expected to follow a similar pattern of post-COVID consumption, with consumers enthusiastically pursuing “revenge spending” in the Year of the Rabbit. An estimated RMB 6.6 trillion in excess savings has been built up during three years of zero-COVID policy, which should in part act as a driver.
The key question is what happens after the initial phase of reopening and whether increased consumption will translate into higher earnings in the corporate sector. Inflation is forecast to remain subdued in China during the Year of the Rabbit, partially due to the decline in energy prices from their peak, the stable domestic supply of agricultural commodities and sourcing commodities from Russia, which has emerged as a pariah state in the developed world. As such, Chinese purchasing power is not expected to weaken.
Corporate earnings should deliver, eventually
From a corporate earnings perspective, the near-term outlook remains weak as companies struggle to scale up production and distribution in the face of COVID-19 pandemic. Additionally, the outlook for the real estate sector is lacklustre, and credit demand may take time to recover, which is likely to act as a drag on the financials sector. However, we expect earnings to recover in the second half of the year as supply chain issues are addressed and the real estate sector stabilizes.
One of our areas of focus is on the electrification of transportation, which includes batteries used in electric vehicles. The structural outlook for this sector remains positively charged.
Market outlook is positive, but uneven
After ending its zero-COVID policy, China embraced economic reopening despite the societal costs. Policymakers have gone out of their way to bolster external relationships, (e.g., with Australia) and rolled out policies to mend the economy (e.g., in the real estate sector). However, the cost of capital remains elevated, partly due to higher rates in the developed world and state crowding out of the private sector domestically. In addition, weak demographics in China need to be addressed. Renewed freedom of movement combined with incentives to start a family could help reverse recent data showing a contraction in the population. China has the largest weight in emerging market indexes and has strong trade links with other emerging markets. A strong and recovering Chinese stock market should be good for emerging markets.
Leadership in a multi-polar world
The world leaders of the current generation are powerful, and their authority seems to be unrivalled. However, many of these leaders have strong agendas which have resulted in turmoil and conflicts, such as the Russia-Ukraine war. Persistently high inflation in Turkey creates risks for President Erdogan as he prepares for elections in June of this year. State elections in India later this year could give an indication of how President Modi and his BJP party will perform in national elections in 2024. The Year of the Rabbit is likely to see world leaders continue to re-balance global power, and we expect governments in the developed world to also court other countries. The world still awaits a Jade leader.
What it means for investors
Given the steep declines in emerging markets in the latter months of 2022 and a strong start to the year, the Year of the Rabbit may well require investors to be flexible and opportunistic. Argentinian football player Lionel Messi was born in the Year of the Rabbit, and we are hopeful that in the year ahead, emerging markets will perform as well as Argentina did during the 2022 World Cup.
