Fidelity China Special Situations (LON:FCSS) is the topic of conversation when Hardman and Co’s Analyst Mark Thomas caught up with DirectorsTalk for an exclusive interview.
Q1: You called your report on Fidelity China Special Situations, “The Peking duck is not burning to a crisp”? What is your brief summary of it?
A1: In this note, we reviewed China’s economic outlook and, in particular, we put the well-publicised COVID-19-related lockdowns into a relative global perspective. The IMF’s July forecast saw China’s real GDP forecasts cut by 1.1% in 2022 and 0.5% in 2023 so things are slowing. With further lockdowns since, there is risk on the downside.
However, the 2023 GDP cuts were a fifth of those seen in the US/Euro area, and China’s 2023 forecast growth is a remarkable 4x their level. Importantly, when you look at the stock market ratings, they are below both. Also, investors should consider what the policy responses from the Chinese government may be if things do slow further. They have reacted already, but there is a lot more ammunition in the arsenal.
Looking at the trust, as a geared play, with some whole-market exposure, FCSS has suffered from market sentiment, even though its stock selection has added value.
Q2: So, can you tell us a bit more about the risks to growth?
A2: China’s zero COVID-19 policy is well covered in the press. It was dramatically felt in the spring with the full or partial locking down of key centres such as Shanghai, where a full lockdown was initially imposed on 28 March, and Beijing and that was evident in the official economic statistics. The policy had direct economic effects of weakened demand but also the indirect effect of problems with supply chains.
More recently, we have seen stories of authorities trying to quarantine people in the Ikea store in Shanghai and the lockdown of Chengdu, a city of 21m people, when it had just 157 new cases. We believe concerns about the economic consequences of the potential recurrence of lockdowns have a been a major driver to the recent weakness in Chinese markets, which at the time of our report had fallen 15% since the start of July. As a geared play, with some whole-market exposure, FCSS is exposed to this sentiment, despite the value added by its stock selection.
Q3: And putting that into perspective?
A3: The world economic outlook is challenging with different risks in different regions but just taking the latest economic forecasts from the IMF, China’s forecast 2023 growth is circa 4 times that of US or Euro area and nine times that of the UK. It may not be as good as it was, but it is still much, much better than other developed countries. Perhaps equally importantly, the degree to which the growth forecast in China has been cut is significantly less than elsewhere. For 2023, the IMF reduced its forecast by 0.5%, but this represents just under one tenth of its previous estimate.
By contrast, in Germany, the 1.9% reduction in real growth represents a reduction of nearly three quarters of the previous growth estimate. For the US, the 2023 growth forecast was more than halved, as it was in the UK. In Japan, it was cut by nearly a third.
Q4: And what is built into market prices?
A4: China’s superior growth is not built into its stock market ratings, which are well below the US level and slightly below Europe’s. There are of course a lot of factors that go into the rating but, fundamentally, you would expect long-term growth to be a major factor driving them.
Q5: And, finally, you highlighted government action. What did you mean by that?
A5: We also believe that many investors have given relatively little attention to what the government may do about the problem. Our experience is that markets frequently underestimate the impact of policy responses to crises until such responses have been announced. This was certainly the case for Western markets in the early stages of COVID-19. Even though governments do react to crises, markets do not always give them credit in advance for doing so.
A significant set of stimulus programmes has been announced already but it is just a faction of historical support. In the past, stimulus has been as high as 20% of GDP, for example, in 2009. Further stimulus packages are likely to be well received. We also believe that regulatory risk, which was high last year is likely to abate for a while. Geo-political tension, as we highlighted in previous notes, is likely to be a feature for the long run to varying degrees. At the moment it is perhaps at an above-average level, but investors should not expect it to disappear.
The UK’s largest China Investment Trust, Fidelity China Special Situations PLC, capitalises on Fidelity’s extensive, locally based analyst team to find attractive opportunities in a market too big to ignore.