In the past year, investors avoided Chinese stocks due to their unattractiveness compared to global peers. Hopes for a post-pandemic recovery boosting market sentiment have been dampened by recent macro data showing a bumpier recovery and looming risks of policy uncertainties and economic headwinds.
The tones coming out of businesses and consumers were extremely conservative this year, says Nicholas Chui, senior vice-president and portfolio manager at Franklin Templeton for emerging markets equity. He adds that this has led to slowing earnings growth, dragging the performance of Chinese equities.
The MSCI China All Shares, for instance, is down 9.56% over the past year as at Aug 31. In comparison, within the same period, the Nikkei 225 is up 16.12%, the S&P 500 is up 15.94%, and the MSCI Emerging Markets is up over 1.69%.
On a relative basis, other countries had reopened much earlier than China, Chui highlights. “We should remember that it has only been less than a year since the reopening and any recovery takes time, similar to other countries,” he adds.
Acknowledging the souring sentiment among investors, Lombard Odier senior macro strategist Homin Lee says the Chinese equity markets still have genuine potential, considering the size of the economy as well as the thriving tech and hardware sector powered by the robust pool of high-quality talents. “There is significant upside potential to this market, which — given where the valuations are — is one of the cheapest markets around once there is a policy shift,” says Lee.
China has already made some changes to support the economy. In June, the People’s Bank of China cut onshore benchmark rates by 10 basis points. This was followed by an extension of the measures introduced to revive the depressed real estate sector, as well as the introduction of a package of tax relief measures for small businesses and rural households.
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On July 7, China imposed more than US$1 billion ($1.36 billion) in fines on tech giants Ant Group and Tencent Holdings, potentially signalling an end to its regulatory crackdown as well as the resumption of approvals for the country’s tech platforms to list private companies.
Lombard Odier is cautiously optimistic about China in the short term. In the long run, the stance could only change if there are concrete reform signals for the domestic real estate market and financial liberalisation, says Lee.
He points out that investors will have to acknowledge that there are challenges. For one, the US presidential election is taking place next year, which means the geopolitical friction between the two largest economies could intensify.
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“Before the end of next year, there will be an opportunity for a face-to-face summit meeting between [US and Chinese Presidents] Joe Biden and Xi Jinping, so they could keep things stable until then. But we cannot rely on this calm continuing next year, hence it is important for some sort of reform measures to be put forward to offset some of the potential negative developments on the geopolitical front,” says Lee.
Further policy easing
For China, combatting deflation depends primarily on stabilising the real estate market where transactions are slowing after a brief respite in the first quarter. This is on the back of the property sector turmoil in 2021 and 2022, which is continuing to weigh on borrowing demand as consumers worry about whether developers will complete projects and about prices, says Lee.
He adds that an estimated two-thirds of China’s consumer wealth are tied up in real estate, which further underscores the market stabilisation. “The share of real estate in the average household wealth is very high in China compared to other markets, where financial assets take a bigger share. Hence, this uncertainty and fear seem to be clearly a factor in the slowdown of consumption growth. To achieve the 5% target put forward by the National People’s Congress, they need greater domestic demand, and certainly consumption is the key part of that.”
To spur the slowing housing market, the Chinese authorities have started to announce several easing measures and Lombard Odier is expecting further restriction dilution. On Sept 2, Chinese authorities announced that it would allow first-time home buyers to enjoy preferential mortgage rates regardless of their previous credit records. Home buyers will not be regarded as first-time buyers if they do not own property in the city, enabling them with smaller downpayment requirements and lower borrowing rates.
Lee expects other restrictions to be further relaxed, such as the “three red lines” policy introduced in August 2020 to help control the highly indebted property development sector. The easing of such measures could be complemented with continuous monetary policy support, he adds.
Tactical opportunities
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When it comes to opportunities in the Chinese equities market, Lee recommends the consumer sector, which benefits from the Chinese Politburo’s domestic consumption boost plan. The Politburo’s sector targets for support include automobiles, electronics and home-related foods, as well as services such as sports, leisure activities and tourism.
China’s IT hardware and consumer internet sectors have been beaten down over the past year. Despite the slight recovery in the past few weeks, these companies are still quite cheap compared to their developed-market peers, says Lee. These companies could benefit from further growth boosts supported by deregulation, he adds.
More aggressive investors can start looking at opportunities in the industrial and material sectors which are set to benefit from a probable rise in capital expenditure as the economy improves. However, Lee notes that it is more difficult and requires a higher risk appetite.
Agreeing, Franklin Templeton’s Chui also flags opportunities in the manufacturing sector, especially in industrial equipment. He explains that China has one of the largest supply chains globally, spanning upstream to downstream. This, coupled with years of research and development, has given rise to an ecosystem that has created many leading-edge industrial equipment manufacturers — which is why many companies still source from China, he adds.
“This is hard to replace in a short time. What is changing is also the downstream demand within China itself. China has moved on from being just a supplier and factory to the world to being a high-end consumer itself. This allows for a lot of the equipment and know-how to be consumed in China,” says Chui.
Chui also highlights the banking sector, on the back of stable earnings and strong asset quality accompanied by attractive valuations. He says China historically has had a strong culture of building savings, creating strong potential for the savings to be deployed and reinvested via channels such as financial institutions and capital markets, helping to fuel wealth creation in the country.
China’s determination regarding sustainability should not be ignored. Aside from being broadcasted by all levels of the government, Franklin Templeton — as bottom-up stockpickers — is also seeing the message being executed by companies. Against the backdrop of a global sustainability push, China plays an important role in transitioning not only its own economy but also the world’s, says Chui.
Lastly, China’s new era of growth involves software systems. Despite a historical focus on hardware, there has been a recognition that software is important in boosting productivity, notes Chui. “We are starting to see companies provide good solutions. We think that this is an area that will continue to develop in the right direction,” he adds.
