Year of the Snake: China faces ‘short term pain for long term gain’

As China welcomes in the new year today, markets are hopeful that the government’s strategy of ‘short term pain for long term gain’ is enough to push the Chinese economy to a new stage of development.

In traditional Chinese culture, the Year of the Snake embodies qualities of introspection, transformation and adaptability.

That year seems fitting for 2025, as after three years of decline, the Chinese equity market delivered a positive return in 2024 and outperformed the majority of other emerging markets. It hopes to achieve even more this year.

Turning things around is the core message out of the mouths of China analysts, with the government abandoning support for the country’s real estate market in the hope that new industries will emerge.

Meanwhile, Chinese equities still trade at a 30-40 per cent discount comparing to other emerging markets (and more than 50 per cent discount to the US) on a price-to-earnings basis, leaving stockpickers eager to scoop up cheap shares.

Real estate in China

The primary focus of Western investors for China has been its unstable property market that is currently in the midst of collapse.

Naturally, markets are obviously concerned over a government willingly letting a property bubble pop, and analysts credited China’s low prices in part to the crisis.

“At its peak, real estate accounted for 20 to 30 per cent of GDP, and that’s coming down quite significantly, so that’s going to have a big drag on the economy,” explained Sharukh Malik, manager of the Guinness Greater China Fund.

In response to the rapid fall, the Chinese government has walked back some policies that caused the property bubble collapse, and monthly property sales data saw positive rebound in the autumn.

Since then, sales growth started to moderate and many cities, especially in the lower-tier, have turned negative again this month.

“The sense is that policy easing released some pent-up real demand, but it hasn’t been sustained as consumer confidence remains weak,” explained Xin-Yao Ng, co-manager of Abrdn’s Asia Focus trust.

However, a significant amount of the credit that was being extended to the real estate sector is now being diverted towards new core industries, with the aim of pushing China up from a middle-income country to a rich country.

“From a policymaker’s perspective, China’s GDP is $12,000 per person. What will take that to $30,000 and make China rich?,” asked Malik.

“It’s not real estate, because no country in history has become wealthy that way. It’s not other areas which investors have traditionally liked, like video games or e-commerce.”

Instead, Chinese policymakers are targeting subsidies at key areas up the value chain, such as electric vehicles, low to mid-end robots, the chip sector and the pharmaceutical industry, in the hope that the country can endure short term pain for long term gain.

New industries

“Chinese companies are becoming increasingly competitive at a global scale. They are transforming from producers of cheap, low-quality goods to leaders in a number of globally critical industries,” explained Qian Zhang, investment specialist at Baillie Gifford China Growth Trust.

Zhang pointed to a variety of Chinese firms competing with western companies, from white goods producer Midea and battery giant CATL, to the world’s largest electric car maker BYD.

“Western semiconductor restrictions have also forced a new collaboration mechanism among Chinese semiconductor companies and some domestic leaders are starting to emerge,” she added.

As a result, Malik predicted that these areas would slowly increase in productivity, eventually overtaking the real estate market in value by as soon as the end of next year.

Analysts were confident that the government was planning to introduce wider fiscal stimulus for these industries, primarily to boost domestic demand.

“What is encouraging for us is there have been clear signs of a policy pivot from Beijing since last September, with a coordinated ‘pro-growth’ push from both monetary and fiscal sides,” said Baillie Gifford’s Zhang.

“Policymakers recognise the risk of geopolitics on export growth, which had been the only bright spot for the economy last year,” added Abrdn’s Ng.

“I expect actions to be more responsive to measures by Trump however, in the sense that stimulus will be stronger if US measures are tougher, and lighter if Trump remains more measured than expected,” he added.

Trump’s tariffs

Despite strong words from re-elected US president Donald Trump on China, most analysts were sceptical that the tariffs will be as radical as he’s making out.

Trump has pledged to install 10 per cent tariffs on all goods from China as soon as the end of this week, but analysts expect the tough talk to be used as a negotiation tactic.

“If [Trump] does go very aggressive on tariffs, that is going to have a massive impact on the American consumer, and I think he knows that,” said Malik.

“The Americans also don’t want to cripple to Chinese economy, because that would have massive negative implications for global growth”.

Even if a trade war erupted, Malik noted that many firms in China had been preparing for this event for years, with factories and businesses moved out of China over the last decade.

In fact, despite the initial impact of the first trade war in 2018, Chinese markets rallied from 2018 to mid-2021, until radical Covid policies and regulatory crackdowns eventually scared off investors.