At the end of last year investment strategists had locked onto three catalysts that might improve market fortunes in 2023. A faster than expected fall in inflation, an end to the war in Ukraine and third, a reopening of China’s economy from its Covid-zero policy. Inflation is easing but has a long way to go before reaching central bank target levels and may prove sticky the closer it gets to targets. Russia has scaled back its demands for regime change in Ukraine, but negotiations for a face-saving exit have yet to commence. China, however, surprised the world with the speed of its Covid policy change. Beijing is now wholly committed to beating the virus through herd immunity rather than isolation through strict lockdowns. China removed all domestic and international Covid restrictions in December.

One of the key catalysts for better equity market returns over the next 12 months is firmly in place largely explaining the year’s strong start. OAM increased portfolio equity exposure in early December and what better way to do so than via China and the Far East. On 5th December OAM added Fidelity China Special Situations PLC (FCSS) to our Global Growth portfolios and Schroder Oriental Income Fund Limited (SOI), more conservative due to its greater regional diversification and higher dividend yield, to Global Balanced and Global Defensive portfolios. Both investment companies are listed on the London Stock Exchange.

Dale Nicholls, the manager of FCSS, highlighted that market sentiment is “probably the worst I have ever seen.” As a result, China’s share prices are offering considerable value. Valuations dropped to all-time lows relative to developed markets. China’s banking sector is close to the valuations that US banks traded at during the depth of the 2008/09 Global Financial Crisis. FCSS is finding a plethora of investment opportunities, which is reflected in a relatively high gearing level, currently at around 25%. FCSS has performed well since Dale Nicholls took over as manager in April 2014 with a net asset value return of 10.6% per annum compared with 6.6% for the MSCI China index. The share trades at an attractive 10% discount to net asset value.

SOI provides conservative exposure to China’s expected recovery. The whole Far East region stands to benefit as China emerges from one of its worst years on record with the lifting of Covid restrictions, reduced regulatory threats and greater monetary and fiscal stimulus, much of it aimed at restoring confidence in the property sector. SOI is conservatively managed, targeting companies with strong balance sheets and progressive dividend policies, driving a combination of both capital growth and income returns. SOI trades at an attractive 4.7% dividend yield and has delivered a growing dividend every year since its listing in 2005. Many Asian companies are increasingly focused on dividends as a contributor to shareholder returns. Overall dividend pay-out ratios in Asia look undemanding and companies have low indebtedness. The company’s defensive characteristics are illustrated by the 2.5% increase in NAV in the financial year to 31st August 2022 compared with a 7.7% fall in the MSCI Pacific ex-Japan index.

It has been one of the worst years on record for China’s economy and its equity markets. The combination of strict Covid lockdowns, property woes and regulatory crackdowns impacted economic activity and investor sentiment. The country’s 20th Party Congress caused even more alarm among investors as President Xi Jinping cemented an unprecedented third term in office. For the first 9 months of the year, GDP grew by 3.0% on the year, and for the full year is expected to be lower still, well below the official target of 5.5%.

The lifting of Covid restrictions dented growth even further in December due to the spike in infections, hospitalisations and people staying away but according to commuter statistics and shopping mall footfall the country is past its peak and activity is rapidly returning to normal levels. Two years’ worth of pent-up household expenditure financed by precautionary savings is expected to result in a surge in consumer spending. The depressed property market is unlikely to contribute to GDP but by the same token it is no longer expected to detract from growth.

Fiscal and monetary stimulus are being directed at moderating the pace of the property market’s readjustment and reduce its burden on the broader economy. In the biggest rescue operation yet, in early December major state-owned banks announced large credit lines to solvent property developers. There has been an easing in the so-called “three red lines” policy, restrictions aimed at deleveraging the real estate market imposed since August 2020. Meanwhile, the threat of further regulatory crackdowns on the private sector, in particular tech companies, is likely to diminish as government prioritises economic growth. The chairman of the China Banking and Insurance Regulatory Commission told the official state news agency Xinhua that the crackdown on technology companies is “basically over.”

China’s GDP is unlikely to recover at the same heady pace that it did in 2021 when the nation rapidly emerged from the initial pandemic wave. That year GDP grew by 8.1%. Global export demand for China’s manufactured goods has since slowed and the property market will be neutral at best but growth of 5-6% is being projected, which should underwrite solid earnings growth and provide a boost to the entire Asia-Pacific region. According to independent research firm MRB Partners, the 12-month forward earnings estimate for the dominant consumer discretionary sector is already 12% higher than it was 6 months ago.

As well as benefitting the Asia-Pacific region China’s economic recovery will boost world GDP, reducing the risk of global recession and limiting the severity of expected recessions in the US, Europe, and UK. China is the world’s second largest economy. Some analysts have flagged the risk that China’s recovery could jeopardise the decline in inflation.

There are concerns that increased demand for imported goods in particular oil and industrial commodities could cause inflation to spike again. Although the oil price may not retreat as much as previously expected most risks to inflation are benign. The full removal of China’s supply chain disruptions should ease rather than aggravate inflationary pressures. According to independent research company Capital Economics “China will likely return to being a source of goods deflation.”