As the value of global equities continues to fall amid fresh interest rate hikes by the US Federal Reserve, Chinese stocks have extended their recent outperformance and rallied to their highest level in three months.
Investor sentiment towards Chinese equities appears to be improving amid a slew of positive policy developments. Authorities have rolled out new stimulus measures to support the economy and Beijing has dialled back its crackdown on the key technology sector.
Meanwhile, the pandemic situation is improving, and Covid-19 restrictions are starting to ease after weeks-long lockdowns in key cities such as Beijing and Shanghai. Despite the conditions, the Chinese stock market is showing incredible resilience against the global equities selloff.
Leveraging Hong Kong’s Stock Connect trading scheme, foreign investors bought around $5.5 billion worth of equities listed in Shanghai and Shenzhen last week, taking foreign inflows into China’s stock market to roughly $6 billion this year. This indicates that some investors believe the worst may be over and holdings are above levels of early March when the sell-off began, according to Financial Times.
Although the situation appears to be improving, the Chinese economy continues to face downside risks as Chinese authorities remain committed to the zero-Covid policy.
Given the highly contagious nature of the Omicron variant, authorities appear likely to impose new restrictions in response to fresh outbreaks should they occur late in the year. Analysts and investors appear to agree that this dynamic will remain a drag on China’s economic activity.
Against this backdrop, AsianInvestor asked fund managers how they view China’s stock market upturn and whether they expect the trend to continue over the next 12 months.
The following responses have been edited for brevity and clarity.
Mary Nicola, portfolio manager, global multi-asset
China's shift to a “dynamic zero-Covid” policy, coupled with a stimulus plan, has initiated a reopening of its economy. This is good news for Main Street but will resuscitate the bad news for Wall Street. By “slowing the slowdown,” China’s economic revival will put to rest fleeting hopes for a Fed pause or a peak in inflation. Infrastructure is the central plank of the government’s multi-faceted plan to revive China’s economy, perhaps making “old economy” stocks the biggest beneficiaries.
In parallel, the steady flow of stimulus announcements has continued on all fronts (fiscal, regulatory, and monetary). After several years of China equities underperforming, they now appear fairly valued. Meanwhile, meaningful acceleration of their fundamentals lies ahead as earnings elsewhere deteriorate. China’s reopening should pressure oil and industrial commodities higher, pairing an acceleration of headline inflation.
Nicholas Yeo, head of China equities
Authorities have cut rates and accelerated approvals for infrastructure projects, bolstering investor confidence. This easing will stimulate economic activity and consumption. Regulatory pressure is also dissipating. We expect China to maintain relatively loose monetary policy for a considerable time – typically stimulative for equities.
However, it’s still early for China’s economy to show strong signs of recovery following measures to counter the pandemic, so we expect the market to remain range-bound in the short term. We view recent supportive comments from the government as a positive signal and we remain constructive on the outlook for 2022 as stimuli work through the system in the second half.
The MSCI China A Onshore Index is also cheap with a forward price-earnings ratio of 14.4x, below its five-year average. At the same time, market trading is dominated by retail investors influenced more by news headlines than company fundamentals. This is leading to a mispricing of quality assets.
Importantly, China’s long-term growth potential remains intact amid rising prosperity and urbanisation. As a fundamental stock-picker, we look for companies able to adapt to regulatory change and those that align with China’s policy goals in areas such as digital innovation, green technology, affordable health-care, and improved livelihoods.
Martin W. Hennecke, head of Asia investment advisory
St. James’s Place
Investor pessimism that has dominated the perception towards Chinese equities for the better part of the past 12 months seems to be slowly giving way to a more neutral if not very cautiously optimistic view.
Whilst we strongly advocate global diversification as well as long-term investing over any form of short-term speculation, I would point out that there are several positive factors that could drive continued rebound potential over the coming year. They include historically attractive valuation levels, the Chinese government clearly focusing its attention on market and economic support with significant stimulus measures being rolled out, and the realisation by some international investors that China is one of the few countries in the world where inflation has remained relatively subdued so far, which implies that, unlike in the United States, interest rates do not need to be raised anytime soon.
Accordingly, we would recommend that, for all the lingering fears that may remain today, China should not be excluded from global portfolios at this stage, and that anyone with existing exposure should be careful about capitulating at what could turn out to be a very unfavorable timing.
Aleksey Mironenko, global head of investment solutions
We topped up China exposure earlier this quarter as we believe this rebound will last.
The Chinese economy does continue to face multiple downside risks, including a continued commitment to its zero-Covid policy, subdued domestic consumption and real estate investment, a need to replenish savings spent during the lockdown and of course a global goods demand slowdown as Western economies fight off inflation.
Authorities will likely impose new restrictions in response to fresh outbreaks for the remainder of the year. As a result of these challenges, the government will have to ease financial conditions and relax regulatory constraints to stimulate the economy to avoid a recession. In many ways, the next 12 months will run counter to the prior year in China – we expect to see support for the real estate sector, a change in approach to the technology industry, a ramp-up in investment, easing of rates and potentially direct income support for those affected most by the lockdowns.
Government priorities are shifting from zero-Covid only to zero-Covid and growth, a trend likely to accelerate into November. At a time of tightening financial conditions globally, China stands out as having mild consumer inflation and thus the capacity to ease financial conditions.
Chloe Qu, senior manager research analyst
We’ve heard both optimistic and pessimistic views from offshore fund managers during our recent meetings. On one hand, some portfolio managers believed now is the good time to build positions in China as the valuation of China assets has been down to a very attractive level, and they expect China to roll out more supportive policies to boost the economy.
Some managers have taken advantage of the sell-off and added to some existing secular growth positions, while some have also identified new opportunities amid the market volatility. Real estate was one of the favored sectors, where the managers have been very selective while picking stocks within the sector. Some have added to property service management companies and liked them for their light business model. For real estate developers, the focus was mainly on industry leaders as some managers believed these companies are poised to benefit from the industry consolidation opportunities.
On the other hand, some were less constructive on the China market outlook as economic growth comes under pressure. They have been trimming names such as e-commerce company Alibaba and Internet companies such as IQIYI since the beginning of the year, given the regulatory and long-term growth concerns, while rotating into sectors like banks and materials to hedge against the macro risk. Nonetheless, the consensus remains that China offers long-term growth opportunities and is of growing importance in the global investment market.
Rob Mumford, investment manager, EM equities
China has an attractive profile of very cheap valuations, consensus underweight positioning and extreme negative sentiment. This is typically an attractive profile for future returns and if policy stimulus can start to get some traction it could lead to outsized relative and possibly absolute gains. The key is restoring confidence across the consumers, enterprises and investors. More may need to be done by the government depending on the pace and reaction of the tightening cycle in the US and also how difficult domestic areas play out, most notably property. Property is a key area for both business and consumer sentiment and up until now still remains a sector under significant stress and risk to the economy.
Valuations have retraced to levels where China equities look attractive versus history and very attractive versus the rest of the world. The probability of enhanced returns or at the least diversification benefits looks good from this point. We have been adding cautiously over recent months in quality companies that we feel have been overly punished by the recently cyclical pressure yet have confidence given strong franchise positions, credit metrics, valuations and in many cases (secure) yield support. While we can't be sure on time-frame - maybe 12 months given the incentive to create better momentum for the economy into the leadership transition in November - over the medium to long term we are very optimistic of the potential investment returns of these positions.
Kevin Anderson, head of investments, Asia Pacific
State Street Global Advisors
Despite short-term volatility, longer-term trends remain in place including economic growth and rising consumption, technology-enabled transformation of industries, rise of local brands, and supply chain localisation. The degree to which some large companies posted positive surprises in their Q1 reporting indicates the extent to which negative expectations had been priced into China equity markets.
There are signs that some of the factors that have concerned investors may be receding, for example, the declining numbers of Covid-19 give some indications that the economic damage may be contained. While the dynamic zero-Covid policy remains, the government is also deploying monetary and fiscal tools to offset the negative impact of lockdowns. Credit growth in May beat expectations and while the quality of credit growth was low, a sustained increase in credit growth and improvement in quality would be a positive signal to support a view of a rebound in markets.
We need to see consumption returning to trend for a more sustainable recovery, however. Longer term, if we see a significant slowdown in the US or Europe as a result of central bank activity, then this may ultimately create pressure on the Chinese market given it will hurt Chinese exports.