China’s Little Giants

China small cap stocks have experienced a healthy correction over the past few months. If I’m invested, why should I stay? If I’m interested, why should I invest?

We believe Chinese small caps continue to offer a compelling risk-reward opportunity, as current valuations and earnings growth compare favorably to other small cap markets. Smaller companies in China are at the forefront of the country’s economic shift toward innovation, consumption and services. These businesses tend to thrive in productivity- and value-enhancing industries such as automation, technology and new energy. We believe small caps have the entrepreneurial spirit and flexibility to recognize and respond to changing local market trends, including changing patterns of consumption. Additionally, the Chinese government has recognized the importance of these companies and seeks to support growth in what have been termed China’s “little giants.”

What supportive measures do you anticipate emerging from the Chinese government?

The Chinese government has made it clear that “stability” is a key watchword and policy goal this year, both on the political and economic fronts. Since China has not implemented economic easing over the past two to three years, it has room to potentially deploy both fiscal and monetary tools.

That being said, we’d expect supportive measures by the government to be more targeted in nature rather than an all-encompassing stimulus package. Examples of specific actions could include fixed asset investments, consumption-related tax cuts (both to individuals and corporates), as well as monetary measures such as cutting mortgage rates or increasing mortgage approvals that might help support property market stability.

What about the macro environment? To what degree are China small caps sheltered or otherwise from the inflationary pressures and surging prices of oil and commodities associated with the Ukraine war?

The good news is that Chinese small caps are heavily focused on their domestic markets, and have little direct business operational exposure to Russia or Ukraine. However, despite the lack of significant exposure to Russia/Ukraine, it is difficult to be completely shielded from the negative effects of these larger macro forces. For example, the global risk of inflation, rising rates and higher energy prices could adversely affect sentiment and consumer demand, which would have negative ramifications on growth.

What do you like about China’s small companies right now?

Small businesses continue to be an important driver of China’s economy, accounting for a sizable portion of economic output. Additionally, many smaller companies are well-aligned with governmental policy initiatives such as self-sufficiency across important supply chains, including technology and green energy given China’s move to carbon neutrality. The green energy theme in particular is a very secular one in our view, encompassing opportunities in solar and wind power, electric vehicles (EVs) and the push for creating a smarter electrical grid.