Volatility Creates Opportunity in China’s Equity Market

Nick Niziolek, CFA

We believe the Chinese equity market is oversold—and as long-term investors, we’ve been taking advantage of downturns to build our allocations in some of our favorite names. Here are a few reasons why we’re positive on the long-term prospects of many Chinese equities:

1. Disruption and volatility create opportunity. China is the second largest economy on the planet with more economic growth and disruption than anywhere else. Disruption causes volatility—as we saw when the Covid-19 crisis began in 2020, but it also creates significant opportunity, which we’ve seen throughout this pandemic cycle. While the current changes in the regulatory landscape in China are creating significant near-term volatility in the markets, these changes are also creating opportunities that we are exploiting in the Calamos global and international strategies.

2. Chinese equities are finding their footing. Since mid-August, China equities have outperformed global equities, including U.S. equities. Chinese internet stocks have bounced nearly 20% from August 19 through September 3. And, the Chinese-equity-dominated MSCI Emerging Market Index has more than doubled the return of the S&P 500 Index over this period, gaining 6.8% versus the U.S. market’s return of 2.9% over this period.*

3. Our convertible experience helps us maximize our upside equity opportunity, while potentially reducing downside risk. Over recent years, Chinese companies have increasingly chosen to access the capital markets by issuing convertibles. Today, the Chinese convertible market is valued at more than $35 billion (USD), including 11 issues of $1 billion or more. We’re also using our extensive experience to build risk-managed exposure to companies that do not issue convertibles, by constructing synthetic convertibles.

4. For a number of industries in China, regulation will create tailwinds for growth. As we’ve discussed in our “Visible Hand” series, the Chinese government is committed to localizing supply chains, promoting social stability, and maintaining firm control—and these priorities support growth across the Chinese economy. This would include fitness, semiconductor companies, smart manufacturing, clean energy, artificial intelligence, cloud services, autonomous driving, 5G and the internet of things.

   In contrast, we are neutral toward sectors where we believe regulators will take a more balanced approach between promoting growth and increasing regulation. This includes luxury goods and internet companies. Finally, we have no exposure to the housing and education sectors, areas where we believe regulation will increase. We’ve also taken a very selective approach to health care, another area that is likely to face increased regulatory scrutiny.

5. China’s brand of communism does provide significant room for innovation and growth, and the CCP will continue to prioritize China’s strategic economic aspirations. As we discussed in a recent post, China is also quite proud of the success of many of the companies it has recently targeted with increased regulation. Overall, the intent is to chasten, not crush these global brands. Although internet companies are now under the regulatory microscope, the Chinese internet sector was very loosely regulated for more than a decade. China is grappling with the same issues we are seeing in Europe, U.S. and other countries that are increasingly concerned with the size and power of these very large platforms. The reality is many of these policies and concerns are also showing up on the shores of developed markets or will be doing so shortly. The key difference is that most developed market countries have dual- or multi-party systems.

6. We expect regulations to moderate. Historically, Chinese regulators have often pulled back if they come to realize they’ve gone too far. We saw this with the anti-graft campaign, the white-liquor review, and the supply-side reform. As we discussed in July, we believe recent remarks from the Politburo signal a more moderate tone on regulation. While we don’t anticipate the government will ever have a light hand, we do believe regulatory and fiscal policies will become more structured and better telegraphed, which market participants will appreciate. If we are right and China begins easing regulatory and fiscal policies, it should be very positive for Chinese and emerging market equities over the next 18 months.