Recent Chinese equities trading, both onshore and offshore, could look very sentimental – it plummeted dramatically in the week of October 24 right after the Communist Party of China unveiled its new seven-strong core leadership group, but then rallied off the cheap valuations fueled by rumours that Covid restrictions might ease.
In the week of October 31, cheered by news that China increased the number of international flights and rumours that the top leadership is considering exit plans to zero-Covid, the offshore Hang Seng Index (HSI) jumped a whopping 8.7% from a rock bottom of 14,597 points. Similarly, onshore Shanghai Shenzhen CSI 300 roared by 7.3%.
After the dramatic selloff and rally in the past two weeks, the market seemed to calm itself and resume logical, when we saw the rally halted with the HSI slipping 0.9% and the CSI 300 dropping 2% as of the afternoon on Thursday November 10, as Covid infection surged across several mainland cities and the central government reiterated stance on zero-Covid.
Some technical indicators have suggested that the worst might be over. For example, short sales as a percentage of total turnover in Hong Kong are declining from a record high, according to research by GROW Investment Group.
However, the macro environment in the global market as well as in China still presents a lot of uncertainties, from rate hikes, geopolitics, China’s slowdown and unclear economic stimulus measures, to how long it takes before zero-Covid restrictions start to loosen.
This week, AsianInvestor asked fund managers whether the worst is over for Chinese equities and their outlook for the next few quarters.
The following contributions have been edited for clarity and brevity.
Cynthia Chen, portfolio manager, Asia ex Japan equities
Economic activity in China has slowed down, and because of the relatively low visibility of the end of Covid controls, the market has been cautious about pricing in significant expectations on policy relaxation. Should the status quo remain in the next several months and barring any unexpected major market events, we see limited further downside in China equities, setting up an opportunity to build up exposures in high-growth sectors.
Should the opposite happen, the upside might be significant. We believe Chinese equities offer tremendous opportunity for value seekers as valuations have significantly fallen for high-quality companies that are expected to bounce back quickly once controls ease.
In addition, we expect continued policy support, though calibrated to avoid creating the bubbles of the past. We see Hong Kong-listed Chinese equities presenting even more attractive opportunities as they fell more versus Chinese equities listed onshore when onshore Renminbi depreciated against Hong Kong dollar.
Ben Bennett, head of investment strategy and research
Legal & General Investment Management
While Chinese equities have been rallying recently, the Hang Seng Index is just back to where it was before the Party Congress - from October 14 to November 8, while the Shanghai Shenzhen CSI 300 is still down. We haven’t heard official announcements of Covid restrictions being loosened. Indeed, statements during and following the Party Congress have affirmed the current policy. So, I suspect the recent bounce has been driven more by a temporary reversal of rock-bottom sentiment and positioning rather than any fundamental improvement in China’s investment backdrop.
Remember that the Hang Seng Index is still down nearly 30% while the CSI 300 has lost nearly 25% during the year to November 8 – you often get dramatic, but temporary, recoveries when markets take such a battering.
We don’t think Covid restrictions will be meaningfully lifted in the next three months given the risks posed by seasonal cold weather and a potential infection spike around Chinese New Year. Some people hope this could change in the second quarter of 2023 as we get better treatments and vaccination rates to improve, but we need to see meaningful progress on both counts to become confident. Other things that could provide a more sustained boost for Chinese equities include more support for property companies, less aggressive tech sector regulation and an improvement in US-China relations. Given the lack of progress so far, it’s probably best to stay on the sidelines for now and ignore the bear market bounce.
Alec Jin, investment director of Asian equities
We are still cautious at this stage. The dynamic zero Covid policy remains in place and continues to weigh on the economy, while the real estate sector is another pressure point. We would need further clarity on these two fronts before we turn more sanguine with regard to the sentiment around Chinese equities.
With the 20th Party Congress just over, we think that a greater alignment of interests among the top leadership could greatly enhance policy execution in future. Notably, the government narrative remains anchored around improving the resilience and long-term competitiveness of the country. This needs a strong and vibrant economy, and we could expect economic stimulus to continue and infrastructure spending to increase in support of sustainable quality growth.
The government transition is not complete until the National People’s Congress in March 2023, and we will continue to monitor developments. If policy follows the direction set by the new leadership at the Party Congress, we do not foresee the need to make any material changes to our portfolios. Over the longer term, we remain buyers of Chinese equities and think that our five investment themes - aspiration, digitalisation, going green, health and wealth - represent the finest structural growth opportunities in China, and some of the most attractive areas of growth available anywhere to investors.
Alexander Treves, head of emerging markets and Asia Pacific equities investment specialist
JP Morgan Asset Management
While we are expecting key economic policy directions from the upcoming Central Economic Work Conference and National Financial Work Conference, recent rumours that the restrictions might ease caused a sharp bounce, off valuation levels which we believe are cheap.
The macro direction notwithstanding, we continue to take a micro approach as differentiation between company-specific opportunities remains critical. For example, to get a more granular idea of who wins and who loses when the US and China tussle over China’s technology capabilities. In terms of sectors, we overweight domestic technology and renewables, or carbon transition, in the short and medium term given the policy support, while we remain underweight financials and energy.
In the offshore space, we have been adding in recent months to the internet stocks, as we believe they offer better growth prospects than their share prices have factored in. The onshore space remains broad and liquid with a wide range of investment opportunities. It also offers diversification benefits given the low correlation of A-shares with other equity markets.
Lily Chang, senior portfolio manager
Credit Suisse Asset Management
The strong rebound of China’s equity market from October lows has drawn investor attention that the worst may be over for the world’s second-largest stock market. We think growth challenges are well discounted by the market, and incremental positive developments may set the stage for a recovery over the next six to 12 months.
Following the 20th Party Congress, China’s top leadership reiterated economic development as a top priority, pledged to further open up China’s markets, and welcomed the German chancellor in Beijing, the first major global leader to visit in the past three years.
For long-term investors, it is a question of when, not if, China will ease its zero-Covid approach. A further increase in the vaccination rate and availability of treatment drugs and facilities will be important milestones.
While the equity market may face near-term headwinds, in the longer-term, Chinese equities present structural opportunities to global investors. While offshore China equities offer more value, the onshore market offers distinct benefits of a diversified investment universe and direct exposure to long-term structural growth opportunities in China: sustainability, lifestyle and innovation. China remains the leading enabler of global sustainability initiatives in solar power, electric vehicle and energy storage. Lifestyle and consumption would be direct beneficiaries of a gradual reopening. Innovation should continue to be a priority as China accelerates its effort to increase self-sufficiency in critical areas such as semiconductors and high-end equipment.
Jason Liu, head of CIO office Asia
Deutsche Bank International Private Bank
In December, we think China could begin to release more pro-growth policy signals after the Central Economic Work Conference. The downside risks to growth from both domestic and external sources are growing. Policymakers are increasingly likely to respond with more aggressively supportive measures at this meeting. After that, in March 2023, China will hold the National People’s Congress, when the reshuffling of many key government officials will formally happen. Settling personnel issues at this meeting could set the stage for more concrete economic stimulus measures from there.
As China maintains its dynamic zero-Covid policy and the export sector weakens, macroeconomic indicators could remain weak in the near term. Market volatility may remain high on such weak macro data and continued uncertainty over future Covid-19 policies. However, we remain constructive on Chinese equities over the next two to three quarters, as economic recovery could still pick up, supported by more fiscal stimulus. China’s onshore market could see more resilience compared to offshore in the next six months. Offshore market could be more affected by the Federal Reserve’s rising interest rates and the recession risks in developed markets. Meanwhile, the onshore market could be a more direct beneficiary of China’s likely stimulus measures.
Yeo Zhi Aik, assistant portfolio manager of fundamental growth and core China fund
State Street Global Advisors
We see signs that the government is changing its stance on Covid in addition to signs of an acceleration of vaccination pace. These signals of a possible change in stance are sending hope to the market that the eventual end to covid-zero is in sight. We believe several key developments still need to materialise before full reopening can take place. In our view, Chinese vaccines, oral drugs, medical infrastructure and improved elderly vaccination rates are all needed to make significant progress as pre-conditions for full reopening.
Despite the hope of market participants, there may be a bumpy ride before we reach a state of normality, especially given the backdrop of weak macro fundamentals, geopolitical tensions and rising US rates. Importantly, the transition away from large-scale covid lockdowns will also take time.
Despite all difficulties mentioned, China remains the second biggest economy with many good quality companies, which can sustain the current downcycle and come out stronger. As long-term investors, we stand by our philosophy of picking high-quality and sustainable growth companies at reasonable valuations. For the latter, the sharp market pullback has definitely created good opportunities for long-term stock pickers to take advantage of.