Chinese equity markets lagged global peers in 2023 and have had a difficult start to 2024. Anticipation for a sustained recovery following the removal of pandemic related restrictions proved short-lived, as pent-up demand was unable to offset property sector worries and softer consumer sentiment.
As the world’s second largest economy, China matters to global growth and the country achieved an upside of 5.2% GDP in 2023, exceeding the target of 5%, according to official figures. The influence is amplified for emerging market (EM) investors, where Chinese equities account for a third of the major indices. For active fund managers, over or underweighting country allocation as large as China’s directly influences a portfolio’s alpha performance.
China equity experts are generally mixed. Supported by minimal country positioning and undemanding valuations, risk-return could become more favorable if market headwinds subside, according to Louisa Fok, China equity strategist at the Bank of Singapore, speaking to FinanceAsia.
Fok is neutral Chinese equities, as she expects a bumpy, but gradual recovery in China’s economy. As the US Federal Reserve cuts interest rates, a narrowing US-China yield spread refocuses attention back to company fundamentals and supports a trading rebound in the near-term, she said.
In the medium term, Fok prefers the A-share market, adding that while the industry mix could benefit from easing policy measures, onshore shares are less correlated to developed markets and tend to ignore geopolitics. But she notes that a sustainable market rerating hinges on further coordinated policy support, alongside a recovery in the real estate sector and a smooth execution of its debt restructuring.
Bearish consensus
Despite the headwinds, depressed valuations underscore the call for Chinese stocks, analysts say.
Regional investors in Asia extend the bearish tone of foreign investors, cites Christopher Wood, equity strategist at Jefferies, observing an overwhelming cautious tone among EM investors during the brokerage’s investor forum in September 2023.
"Even though valuations look optically cheap, mean reversion does not make China look attractively positioned." Sebastian Kahlfeld, DWS
Peak pessimism usually sets the stage for a market rally. After witnessing multiple disappointing years, the Jefferies quant team argues that China’s equity markets are positioned to outperform, as an appreciating Rmb supports Chinese asset values while a recovery in retail sales and property sectors support the earnings outlook.
But for investors, depressed trading multiples may not be enough. “Even though valuations look optically cheap, mean reversion doesn't make China look attractively positioned,” said Sebastian Kahlfeld, portfolio manager at DWS speaking to FA.
Multiple factors speak against increasing Chinese stock exposure, says Kahlfeld, adding “new surprises, particularly those with an already well-established regulatory framework, are likely to keep risk premiums high, and, in turn, valuations low.”
Investors were reminded of this risk back in late December after Beijing announced new rules aimed at curbing video game use by banning rewards online gamers were offering players. NetEase lost more than a quarter of its value following the announcement.
Ironically, good news did little to move the market in the opposite direction. BYD’s share price was virtually unchanged after the company announced annual sales numbers surpassing Tesla as the world’s largest seller for electric vehicles last year.
Kahlfel points out that while China already boasts a range of highly innovative and successful companies, these stories are already well-known to the investment community. “Even though investments might be allocated to these names, it is very likely that these would be funded from an existing investment portfolio in China, in turn leaving the overall allocation to China untouched, if not falling,” he said.
Property matters
Investors agree that the recovery of China’s property sector serves as a critical factor in determining the sentiment and direction of its economy. However, despite recent efforts aimed at boosting demand, the sector continues to grapple with liquidity issues, hindering meaningful growth.
Those taking an upbeat outlook anticipate more forceful measures from Beijing, however, industry analysts highlight these shortcomings, emphasising the potential shortfall in effectively addressing household concerns.
Kristy Hung, a senior industry analyst at Bloomberg Intelligence, argues that structural changes in supply and policy efforts to build affordable housing could limit the recovery in private new homes sales in 2024.
“Faltering home prices threaten to limit investment demand [while] a persistent liquidity crunch is poised to limit private developers' project pipelines,” adding “[an] impending ramp-up in competing supply from affordable housing could crowd out demand for private residential projects with smaller unit sizes,” Hung wrote in a research note.
Despite the sector’s outsized role in the economy, DWS’ Kahlfeld notes that property's relevance to the overall economy has lessened in previous years, providing some relief should the sector remain sluggish.
Those maintaining an overweight position in Chinese equities are looking for some respite. Current ambitions are arguably similar to those from a year earlier when in late 2022 and early 2023, momentum pushed stocks higher as pandemic related restrictions were gradually eased. The rally eventually fizzled out by the spring, with gains being quickly returned.
Consensus earnings for the MSCI China Index appear optimistic at around 14% according to Bank of Singapore’s Fok, adding that the estimates are likely vulnerable to a downward revision when earnings come out in March 2024. That timing overlaps the Two Sessions Meeting when market watchers will comb through policy announcements and growth forecasts, no doubt adding to the China debate this year.
As the Chinese government weighs yet more stimulus measures, there is plenty of reassurance needed for investors at the World Economic Forum in Davos over the next few days
For more FA analysis on China’s debt issues see here.
