Authors
Bernie Ahkong John Bradshaw Jia Tan

Spotlight on China

Heading into 2025, US exceptionalism may be one of the most consensus views in the market. With Trump retaking power, there are Goldilocks expectations for the early part of the year with anticipated tailwinds such as deregulation, improving corporate and consumer optimism and continued easing monetary policy. A period of sustained US industrial growth could provide many opportunities in the US; however, it does not mean that the rest of the world should be ignored. In fact, we see China as a fruitful space for long/short investment given the opportunity set and various factors.

As the markets and events dictate, we would like this letter to highlight our capabilities within our Muti-strategy platform and share views from our portfolio managers. We will end the year with a spotlight on China, from John Bradshaw, Head of O’Connor Asia Pacific, and Jia Tan, Head of Research, China Equity Long/Short at O’Connor.

Nearing turning points

After a rather eventful 2024, we anticipate that 2025 will also be characterized by significant turbulence, coupled with numerous opportunities. Domestically, China is nearing crucial turning points in both its property and industrial cycles, which we see as signals for positive progress in economic transition and financial system derisking, fundamentally impacting capital markets and potentially leading to a market rerating for China despite expected higher geopolitical risks.

Looking at the property cycle, although real estate investment is expected to slow down further, we may see this accelerate housing inventory absorption, thus decreasing supply and raising property values. An important metric to monitor is high-frequency data in the secondary market of so-called tier 1 cities, from which we have seen notable strength since September 2024. We expect inventory in tier 1 and some tier 2 cities to return to normal levels in the second half of 2025, provided the secondary market remains at its current level and the government procurement program becomes more effective. This could lead to more stable housing prices and a moderate investment rebound in 2026. Local governments have seen shrinking land sales revenue from the peak of 8.5 trillion renminbi (RMB) in 2022, down to 6.5 trillion RMB in 2023, and a further slowdown to 2 trillion RMB in 2024. This, together with strict containment of local government financing vehicles (LGFV) debt, has reduced local government funding by about 4 to 5 trillion RMB over the past two years. The recently announced LGFV debt swap plan may further reduce market concerns on LGFV debt risks and provide modest support for local government spending.

Industrial capacity expansion

The industrial cycle, which has offset the impact from the collapse of the property market, has also led to overcapacity issues and a weaker Producer Price Index (PPI). For instance, industrial capacity expansion began exceeding production in 2022, turning PPI negative in 2023 and remaining negative up until November 2024. This has impacted both industrial companies' margins and profitability. Furthermore, according to the National Bureau of Statistics data, manufacturing fixed asset investment (FAI) growth was 9.3% in November 2024, while nominal industrial production remained below 3%. This gap suggests that manufacturing investment may need to adjust to align more closely with demand growth, in order to re-establish sustainable corporate margins. Recent policies moderating loan growth and focusing on risk management and controlling capital expenditure buildup are expected to result in a more sustainable capacity expansion in the second half of 2025. Indicators show that policymakers have begun rationalization since the third quarter of 2024, including reduced window guidance on industrial loan growth, a ban on illegal preferential treatment of enterprises by local governments and the elimination of existing low-efficiency capacity.

Positioning assessment

In 2025, we believe it is critical to assess our positioning in the tech and artificial intelligence (AI) cycle. Since early 2023, China's A-share semiconductor index has lagged the iShares Semiconductor ETF (SOXX), which is expected as the initial phase of major tech waves is commonly centered on semiconductors and hardware, often led by US companies. While we remain optimistic about the demand for graphics processing units (GPUs), AI application-specific integrated circuits (ASICs) and AI networking driven by training and inference needs, there will be a time when investors have to critically examine the return on investments (ROI) from such large capital expenditures. Products or entities like phones, glasses, and agents that can reach the mass market will be areas of focus for us as we believe that Chinese companies excel in business model innovation due to a large population, strong engineering and less focus on data privacy sensitivity. We also see value in Chinese companies that are in the second stage of their AI investment. Despite challenges like potential increased US tariffs and restrictive policies, we believe that advancement of the Chinese manufacturing sector is unlikely to halt, especially when the general trade surplus in China has significantly outpaced its processing trade surplus since 2022. In the face of negative headlines surrounding China’s macro environment and domestic policies and a persistent bear market, Chinese entrepreneurs continue to exhibit strong work ethic, bolstering our confidence in the Chinese people.

Ample alpha opportunities

Given various stages of different cycles and unpredictable factors, the playbook for 2025 is complex. However, irrespective of market outcome, we believe that there are ample alpha opportunities in China across different sectors via a long/short investment strategy. We will look to maintain a defensive portfolio until we have clarity on two key events: Trump’s first policy actions, and the Two Sessions – China's annual parliamentary meetings – in early March followed by a two-month policy vacuum period. We expect some volatility as the Trump administration and Chinese policymakers take turns moving their proverbial chess pieces, and we will continue to focus on downside risk management during this time. By mid-2025, we anticipate clarifying data on the impact of tariff hikes on the domestic market and whether the property market stabilizes and industrial investment rationalizes. As macro uncertainties diminish and the market becomes more functional, we plan to look to rebalance and add risk to our portfolio. As fundamentally driven, relative value investors, we believe 2025 will be another year with alpha opportunities, and we feel well prepared.

C-01/25 OCCRVC-2070

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