Taxi drivers are often seen as one of the most dependable observers of societal conditions. Citing his conversations with them, from Beijing to Suzhou to Shanghai, OCBC economist Tommy Xie concludes that China’s atmosphere is “notably pessimistic”. “All taxi drivers I interacted with believed they were earning less this year for various reasons. One common element cited was the increasing competition from new drivers, many of whom turned to driving as a last resort after losing their jobs,” relates Xie in a recent report.
Such pessimism was not expected. When China finally lifted its pandemic-related curbs after three years, locals, businesses and investors across the world were expecting a quick recovery.
Yet, judging from recent data, market commentators are lamenting one after another that the post-reopening recovery of China has fizzled out and that deeper, longer-term structural issues are catching more attention than before.
Still, upbeat commentators believe the picture is not just a dreary one. There are obvious concerns, but there are also enough reasons for them to stay positive about China.
Bumpy take-off
Kristina Hooper, Invesco’s chief global market strategist, describes China’s post-reopening recovery as a “bumpy take-off”, adding that there has been “meaningful” but “less rapid than expected” recovery, which was uneven.
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While services enjoyed the most pronounced pick-up, manufacturing and exports were softer amid a wider global trend. “Still, China’s near-term outlook remains favourable — growth should accelerate in the second half. China remains a bright spot with subdued inflation and a robust growth outlook,” says Hooper.
The weaker-than-expected showing got some experts, such as the DBS CIO, to acknowledge that their calls have not been fully on point. DBS CIO, in its 2Q outlook, called for an overweight on Asia ex-Japan.
Yet, in its more recent 3Q outlook, DBS CIO notes that China’s market, a key contributor to the sector, was down 6.8% instead.
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DBS CIO attributes this to simmering US-China geopolitical tension, the potential rise of a new “digital iron curtain”, as well as the prevailing property developers’ debt woes and the impact it has on the broader economy, which are valid concerns here to stay.
However, with Chinese equities trading at just 11 times forward earnings, a 36% discount to global equities — a near all-time low — DBS CIO believes China’s concerns have been “substantially” priced in.
Confidence trap
Jian Shi Cortesi, investment director at GAM, believes that Chinese equities are held back for a few key reasons. First, there is the so-called confidence trap triggered by the slow recovery. “People were expecting everything to be boom, boom, boom.”
Companies prefer to preserve cash and not invest. Now, this is not to say businesses, and consumers, are getting more destitute. Rather, their savings are piling up. Cortesi, citing anecdotal feedback from banks, believes that home buyers are in fact paying down their mortgages ahead of schedule. “People are just not spending as much,” she says.
Also, there is the expectation of strong stimulus from the government, but it is not forthcoming thus far. Cortesi reasons that the Chinese government is being careful, adjusting its support without creating problems that will manifest over the longer term.
Another bugbear is China’s real estate, which is in the doldrums because of restrictions imposed by the government to deal with over-leveraging by both developers and consumers. Cortesi notes that real estate prices, following a drop, have stabilised.
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However, construction activities are around 30% below the previous levels, resulting in a knockon effect on related sectors from home appliances to cement and steel. The government remains guarded because of concerns that another bubble might be unleashed and negate recent efforts to let income catch up with prices, she adds.
Escaping from the trap
Cortesi has identified several factors that will take investors out of this confidence trap.
First, look for clear signs of earnings recovery by Chinese companies in the post-pandemic period, instead of just holding steady. When they do so, companies will be more confident to go from conservation mode into growth mode. “This could be a very important catalyst,” she says.
As for geopolitical risks, which has been cited by commentators as reasons for staying away in China, Cortesi notes that there is increasing interaction between US and Chinese officials, which can be interpreted as a sign that while the two countries will see each other as rivals, they also realise that unabated and fierce competition will only harm their own interests and are therefore searching for the common ground.
On geopolitical risks, Cortesi has another observation: somehow, investors have only priced in such risks when talking about Chinese stocks, but not the US, or even Taiwan, both of whose markets have gained significantly this year. “There’s some disconnect between how people view risks, which does not seem to be consistent,” she says.
OCBC’s Xie, on his part, believes that ties have already hit rock bottom and cannot get any worse. Considering the numerous sanctions the US has already imposed on China, “how much more can the US impose?” says Xie, citing an international relations expert he spoke to in Beijing.
Where to invest?
So, where should investors keen on China invest in? Along with a weaker RMB, which makes it cheaper for foreign investors to buy Chinese stocks, the attraction is growing for some market experts.
PineBridge Investments believes that investors should take advantage of the volatility to source for “mispriced” opportunities. “Across services and travel-related sectors, for example, we expect certain high-conviction names to withstand the external disruptions and gain strength as domestic conditions improve following the expected boost to consumption.”
GAM’s Cortesi distils the complex question into this line: Follow the government’s policies. Under the country’s current planning, the emphasis is on innovation, green, social well-being and security, all of which are longer-term goals. In clean energy, for example, many related stocks have corrected quite significantly in line with the wider market, and thus are now looking attractively valued.
Another theme is that of the reforms of state-owned enterprises (SOEs), many of which are listed giants in key industries such as banking and energy. Cortesi points out that many SOEs are trading at below book value. They are also major investment holdings for pension funds. This sector, overall, is one where Cortesi sees “structural opportunities”. Some of the major banks, which are major SOEs, are trading at merely 3x or 4x earnings, while giving yields of 8%.
Cortesi reckons that the government has refused to further loosen curbs on real estate because of worries that prices will again shoot up and bubbles will be formed, negating previous efforts to cool this space. “Ideally, prices should stay stable, while income can catch up. Definitely, investors and speculators are not very hot about real estate now,” she adds.
With real estate not exactly drawing in investments, while bank deposits return just 2%– 3%, Cortesi believes the stock market could be where all the savings can be drawn into. “We are waiting for the catalysts,” she says.
In the following pages, The Edge Singapore suggests a few stocks for a closer look.
BYD: Tesla-beater builds up stronger position amid competition
China Railway Construction: Undervalued giant chugs ahead; seen to be more selective
China Telecom: Industrial digitalisation to lead new growth
Ping An Insurance Group: Riding safely on structural recovery
Sinotruk Hong Kong: Heavy-lifter pulling ahead in the sector
