Market Views: Are Chinese equities a ‘buy’ yet?

Nov 15, 2018

Chinese stock market indices have taken a beating so far in 2018, losing nearly 30%. We asked four experts when investors should start looking at Chinese equities again.

Market Views: Are Chinese equities a ‘buy’ yet?

It's not been an easy year for China's stock markets; after adding on 5% and 7%, respectively, last year, both the Shanghai and Shenzhen composite indices are down close to 30% so far in 2018.

One major factor that has weighed have been the US-China trade tensions, with the two countries engaging in a tit-for-tat implementation of tariffs throughout 2018.

Chinese economic growth is also weaker than expected, with the 6.5% third-quarter GDP growth rate the country's slowest year-on-year performance since the first quarter of 2009.

Chinese GDP growth in the second quarter also disappointed and in October the IMF revised down its projected growth rate for the country to 6.2% from the 6.4% figure it gave in July.

Given the poor year-to-date performance of Chinese company shares and the slowing Chinese economy, we asked a wealth manager, a consultant and two fund managers when would be a good time for investors to start looking at putting money into Chinese equities, and what investors should look out for.

The following extracts have been edited for clarity and brevity.

Elaine Zhou, equity analyst with the chief investment office

UBS Global Wealth Management

We expect a low-teen [percentage] turn in six to 12 months but we suggest a defensive play in the near-term, given our expectations of continued market volatility amid uncertainties around policies, earnings deceleration and external headwinds. Sectors we recommend are financials and industrials. For investors who can stand short-term volatility and look for long-term growth, we still like the new economy in China, such as lending consumer names, healthcare, e-commerce and technology.

Corporate profitability remains resilient in this round of the economic downturn and should be sustained at a single-digit pace for six to 12 months. As such, we think the market should rebound amid signs of government support and thaws in trade conflicts. Value is popping up for Chinese equities given attractive valuations.

We think current valuations have more than priced in the earnings deceleration and domestic slowdown. Chinese equities are now trading below their post-global financial crisis average and close to the bottom in fiscal years 2015 and 2016, when corporate earnings growth was negative and China was facing big macro problems, with serious overcapacity, capital outflows, slowing growth and exports, over-leveraging and a weakened currency.

Sentiment is still weak among clients on Chinese equities ... Investors are still concerned about the trade war escalation as well as the macro slowdown. They have been waiting for more concrete government support to the real economy, capital market reforms as well as foreign investment. As such, more proactive government stimulus might inject confidence into the market.

Janet Li, wealth business leader, Asia

Mercer

We still see Chinese equities as an attractive asset class, but then that's on a pretty long-term basis, and so I think it's hard to comment on short-term market fluctuations.

In the long term China is too big an economy to ignore and there are plenty of opportunities for investment, but right now they're being affected by many external factors ... There are complexities that will have to be worked through in order for investors to be able to have a positive investment experience.

Generally, clients are more interested in healthcare and the technology sectors. Investor sentiment is less positive than perhaps a few years back. The market has been a bit too volatile for them. But for sure, the inclusion of A-shares in the [MSCI emerging markets index] has triggered another look at the China market. ... We have received more enquiries [from clients] related to the inclusion of A-shares, which is a good sign. But in terms of actual change, the clients are more wait-and-see and observing market volatility. Generally, the appetite seems to be there, of course pending a number of issues ... including the volatility of the asset class and the ability to find good local investment managers.

Ken Wong, Asia equity portfolio specialist

Eastspring Investments

Investors should gradually start to reallocate assets into China as consensus earnings growth for 2019 remains solid (MSCI China: 11%, CSI 300: 15%), while reported third-quarter earnings results were mostly in line with market expectations. In 2019, Eastspring anticipates the demand for Chinese equities will continue to grow as more Chinese A-share stocks will be incorporated into global MSCI indices with higher inclusion factors.

While we can’t be certain Chinese equity markets have bottomed, the current risk-to-reward opportunities of investing in Chinese equities are definitely looking more and more attractive. Given the CSI 300 has dropped 25% in 2018 and the MSCI China has fallen by 18%, this makes both markets the top underperformers for equities in 2018.

We believe that the low valuations coupled with low expectations for both the onshore and offshore Chinese equity markets will soon attract investors back, regardless of the geopolitical noise that has been negatively affecting overall market sentiment. Any de-escalation of trade tensions could very well be the catalyst for investors to unlock the evident value.

While clients remain somewhat cautious about investing in China, they are once again starting to look for pockets of opportunities within the market. While they remain concerned over trade tensions, investors also believe that the market’s current valuations and the potential for market mean reversions could make China a potentially good investment opportunity in 2019.

Eric Moffett, portfolio manager, Asia opportunities equity strategy

T. Rowe Price

Chinese equities have underperformed all other major markets year-to-date, but there is a lot to be excited about in this market. Valuations look very cheap, which is partly a reflection of the slowing growth and trade sanction headwinds.

However, a quick comparison shows the MSCI World Index is currently trading at a price/earnings ratio of nearly 20 times, well above the China A-shares market at 12 times earnings. This represents crisis-level valuations for an economy that is still growing faster than most places around the world. That is not to say that they cannot go lower still, but when I look at the Chinese A-shares market today, I see some of the greatest inefficiencies I’ve ever seen.

There are lots of good companies but many of them remain hidden from the gaze of foreign investors. As a retail-driven market, information is not often published in English, nor are investor roadshows a feature of corporate activity. This represents a great environment for finding mispriced opportunities.

Equity market inefficiency and low valuation levels give us good reason to be upbeat. China A-shares represent a deep opportunity set with many attractive companies, a number of which remain undiscovered by foreign investors. It is possible to find blue-chip companies, growing by around 15% a year, at very reasonable valuations. This level of growth may be less attractive to local investors but for astute investors these are quality companies with sound balance sheets.