The Peking duck is not burning to a crisp

In this note, we review 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. 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, China’s 2023 forecast growth is ca.4x their level, and market ratings are below both. Also, investors should consider what policy responses may result. As a geared play, with some whole-market exposure, FCSS has suffered from market sentiment, even though its stock selection has added value.

• Policy responses: Investors should consider i) that it is not in China’s interest to allow a prolonged downturn, which may cause social unrest, ii) the state has considerable firepower to manage the economy, and iii) investors have not fully valued policy responses, as there is not yet visibility on their effectiveness.
• Opportunities: Market dislocations create stock-specific pricing anomalies, which research by a long-established, large, local team can identify. FCSS’s access to Fidelity’s local and global research gives competitive advantages here. We do not believe the market is anticipating policy responses to any slowdown.
• Valuation: FCSS trades at a 9% discount to NAV. The discount has trended down since 2016 but recently rose on regulatory, economic and geo-political concerns. Peer ratings have been volatile (FCSS in the pack), but FCSS’s performance is significantly better. The yield is now 2.2%, and buybacks have been done recently.
• Risks: Further regulation in China is a risk, but FCSS’s exposure appears limited. Geopolitics may affect sentiment, but FCSS is domestically focused. Sentiment can go against FCSS’s investment style. The economic outlook remains uncertain, as is the policy response to it. Returns may be expected to be volatile.
• Investment summary: In general, FCSS invests in the huge opportunities from New China, with growth in the middle classes, and supportive government policies towards domestic demand and innovation, expected to underpin superior GDP growth. Fidelity’s stock-picking, gearing, being able to make illiquid investments, and the compounding benefits from investment outperformance have seen total share returns over 1.5x those of peers over 10 years. There are risks from further regulations, but these may also create opportunities. Investor appetite for FCSS’s style may vary, and investors should expect volatile returns. As noted, the share price is at a 9% discount to NAV.