Credit Suisse turns positive on China, but warns of persistent debt levels

Nevertheless, Credit Suisse is still broadly positive about prospects for Asia. For one, it recently upgraded its rating on China from “market weight” to “overweight”.

While many Chinese companies face uncomfortably high debt pressures, thereby clouding long-term prospects, Credit Suisse still likes China for rea­sons including its low oil import bill, which will help keep costs checked, relative to other economies that are more oil-dependent. China’s 2021 net crude oil and petroleum product im­ports as a percentage of GDP was es­timated to be less than 2%, whereas for Japan it was closer to 3%. Thai­land — which led the pack, accord­ing to figures compiled by Credit Su­isse — imported more than 5% of its GDP (see Chart 1).

Also, China enjoys “insulation” from the US Federal Reserve’s rate hikes, due to its largely closed capital account. As such, Fed rate hikes af­fect China less than most other Asian markets. China stands out globally in being in an easing cycle.

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Another plus factor for China is its limited export dependence. Its 2021 ex­ports as a percentage of GDP stands at around 20%, versus 80% in the case of Malaysia and around 60% for Taiwan.

Citing historical performance dur­ing the global financial crisis of 2008- 2009, as well as the pandemic-induced market panic of early 2020, Credit Su­isse notes that China typically outper­forms when investors are in a “risk-off” mode.

China’s recent 2022 GDP target of 5.5% is also a source of possible cheer. This forecast is higher than expected by the consensus, including Credit Su­isse. Again, if the historical track re­cord is used as a reference, this means China’s GDP might end up at a higher growth rate than 5.5%. David Wang, the bank’s China economist, notes that China almost always meets or beats its targets (see Chart 2).

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Other factors in China’s favour in­clude its range of effective strong short-term policy tools that can be deployed relative to other Asian governments. “In a pinch, increased infrastructure spending and more forceful window guidance for lenders can be rolled out again,” notes Credit Suisse.

Last but not least, despite the trade war with the US, China remains “fierce­ly” competitive, according to Credit Suisse. Last year, its share of global exports increased for the second con­secutive year. The amount of foreign direct investment it was able to attract similarly surged to more than US$300 billion ($406.5 billion).

Nevertheless, Credit Suisse says a few factors are restraining it from be­coming more bullish on China. Firstly, in the wake of restrictive policies over the past year or so, earnings growth among many China companies, across multiple sectors, remains weak, leading to ongoing cuts in earnings estimates. “Macro stabilisation should help earn­ings at some point, but it might take several months more,” notes Cred­it Suisse.

Furthermore, many property de­velopers, saddled with mountains of debt, are still struggling. Credit Suisse notes that while housing prices appear to be stabilising, developer sales and land acquisitions remain weak. “As with earnings, we expect the real es­tate market to eventually respond to loosening measures, but the lag might unsettle markets.”

Last but not least, China as a whole remains an economy with a relative­ly high credit intensity — which re­fers to the amount of credit extended relative to gain in revenue. “Structur­ally, we remain concerned that China has yet to reduce the credit intensity of the economy,” states Credit Suisse.

Credit Suisse’s view is not unique. China equities have undergone sub­stantial derating since early 2021 and the sector is now trading at a 37% dis­count to global equities on a forward P/E basis, versus a long-term average of a 23% discount. “Everything has a price. At current levels, we believe the rewards outweigh the risks,” says DBS’ chief investment officer Hou Wey Fook in the bank’s 2Q2022 outlook.

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Jason Liu, head of CIO Office Asia, Deutsche Bank International Private Bank, notes that year to date, more than 100 Hong Kong-listed compa­nies have launched share buyback programmes, some of them up to a few billion US dollars.

Liu says that as the China Securi­ties Regulatory Commission is explic­itly encouraging listed companies to conduct share buybacks, this trend will probably continue in the coming months. This will provide upside po­tential for Hong Kong-listed Chinese companies. “Although, in the foreseea­ble future, a return to consistently mas­sive outperformance seems unlikely, risk-conscious investors could take ad­vantage of low valuations as well as of possible future temporary setbacks to gradually rebuild their China posi­tions,” says Liu.

Credit Suisse recently too upgraded Australia to “overweight”, citing posi­tive revisions to earnings estimates of Australian corporates. Australia is also seen to occupy a “neutral” position in energy, which insulates its economy from surging fuel prices which are in turn pushing up inflation in other en­ergy importers.

The Swiss bank, too, likes Malay­sia, given how the country is a key ex­porter of various commodities ranging from palm oil to rubber to energy, and is a clear beneficiary of rising prices. Companies listed in Malaysia tend to trade at relatively low valuation multi­ples while enjoying a somewhat “safe haven” status.

Downgrades

On the other hand, Credit Suisse rec­ommends that investors trim their ex­posure to Korea due to the high pro­portion of oil imports, which will drive up costs. It has turned cautious on Singapore too, given the open econo­my’s exposure to US rate hikes. Thai­land, meanwhile, is seen to take a hit from higher oil prices, as well as a fur­ther drop in tourist numbers from Eu­rope because of the conflict between Ukraine and Russia.

Credit Suisse has also called for a “tactical downgrade” of India from “overweight” to “underweight” as high­er oil prices have hurt its current ac­count, added to inflationary pressures, and increased the market’s sensitivity to Fed rate hikes. The market’s big P/E ratio premium also magnifies risks.

Credit Suisse is keeping a lookout for opportunities to re-enter the Indi­an market due to its “strong structural prospects, positive positioning in cred­it and property cycles, and robust EPS momentum”.

From a broader perspective, Dan Fineman, Credit Suisse’s co-head of equity strategy for the Asia Pacific re­gion, recommends that investors stay positive on Asia relative to the US.

In the past nine years, Asia outper­formed the US only in 2017. Howev­er, Fineman, speaking at the recently held 25th Credit Suisse Asian Invest­ment Conference, says that Asia will finally see a “better year” in 2022 com­pared to the US.

Firstly, valuations are cheaper, while the earnings cycle for corporations is “superior”, thanks to lower-wage pressures.

In contrast, the US is at the peak of an earnings cycle and is undergo­ing inflationary pressures that have spilt over to wages, which are now increasing at a pace that is “unsus­tainably high” relative to economic fundamentals.

Fineman explains that the US had mild wage pressures leading up to the years immediately before the pandem­ic, and this has helped boost earnings in the corporate sector. However, wage pressures spiked during the height of the pandemic, which caused com­pressed margins for companies, es­pecially so when productivity is neg­atively affected.

On the other hand, the wage pres­sures in most Asian economies are not as stiff, says Andrew Garthwaite, head of global equity strategy at Credit Suisse.

While wage pressures have risen more sharply in the region before the pandemic, in the “high single-digit to double-digit range”, the pressure has since eased off, the analysts say.

Garthwaite goes as far as to de­scribe the US labour market as over­heating, which will compel the Fed to raise rates until growth slows below trend. He estimates that 60% of costs incurred by businesses come from la­bour and this component is growing at 4.5%, outpacing productivity growth.

While the US may be enjoying its upbeat moments, the same cannot be said for other markets elsewhere. Europe is currently downbeat at this point, largely due to the Russia-Ukraine conflict. Garthwaite thinks that the supply-side shock to commodities, fi­nancial markets, Russia and corpo­rate confidence is being underestimat­ed in Europe.

Europe will also face rising inter­est rates as the European Central Bank (ECB) tapers its asset purchases due to worries about inflation, which hit a record 5.8% in February, according to a report from Reuters. Credit Suisse expects Europe to grow at just 1%-2% this year — a significantly slower pace versus the ECB’s forecast of 3.7%.