China has stopped requiring inbound travellers to go into quarantine since Jan 8, an announcement made during the holiday season that postdates many outlook reports.
The country’s civil aviation authority announced on Dec 28, 2022 it will gradually resume accepting applications for international passenger charter flights from Chinese and foreign airlines.
China will also fully restore pre-pandemic flight procedures and requirements by the summer and autumn seasons in 2023, it adds.
A pivot is underway in China, says PineBridge Investments in a note released Dec 29, 2022. “China is pivoting, signalling support for both its ailing real estate sector and the beginning of a Covid-related reopening. This is supportive for risk assets, yet does not completely offset the rising risk of recession elsewhere,” PineBridge says.
China is the only area where a policy pivot is upon us, writes PineBridge Investments’ team, fronted by global head of multi-asset Michael J Kelly. “Once this is all behind us and China’s economy is on sounder footing, the government will lean back towards centralisation in pursuit of social equity, while in all likelihood slowing the country’s growth rate once again.”
Despite the recent rally in Chinese equities, the country’s slower long-term growth rate is more than adequately priced. Before then, beginning in the second half of 2023, we expect to witness a recovery centred around domestic consumption rather than investment.
See also: How bad could a recession be?
An earlier report by PineBridge highlights “ample opportunities” among the Chinese A-share market. “Valuations have fallen significantly 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,” say Elizabeth Soon, head of Asia ex-Japan equities, and Cynthia Chen, portfolio manager.
HSBC Global Private Banking (GPB) is slightly more optimistic on China, forecasting 5.0% GDP growth in 2023 that will accelerate to 5.8% in 2024. This is up from HSBC’s 3.0% forecast for 2022.
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That growth will not be even though. Fan Cheuk Wan, HSBC GPB’s chief investment officer, Asia, expects China’s GDP to contract 0.5% y-o-y in 1Q2023 due to short-term disruptions caused by the ongoing wave of outbreaks. HSBC expects the current Covid-19 wave in China to peak by the end of February.
Following that, China’s economy should rebound with strong recovery in the consumption sector, says Fan in a Jan 5 media briefing. “[This is] mainly driven by the pent-up consumer demand and the surplus savings accumulated by the Chinese consumer over the past three years of zero-Covid-19 control.”
For now, China faces a “short-term hiccup”, says Fan, but its neighbours could stand to gain by putting out the welcome mat. “We have seen selected countries announcing testing rules targeting Chinese travellers. So far, Asian countries seem to be more receptive to the return of Chinese travellers … We think Hong Kong and Asean will be the top beneficiaries of China’s reopening, especially with China’s announcement to resume international travel starting from Jan 8,” she says.
Fan is “not that concerned” about the short-term hurdle faced by Chinese consumers travelling to Europe or the US. “We expect Western countries to keep reviewing the testing rules, especially when they get more data regarding the risk of new Covid-19 variants,” she says. “So far, we haven’t seen evidence of the China outbreak bringing new variants at this point of time.”
Fertile hunting ground
Chinese equities could become a bright spot in 2023, says Zheng Wenli, portfolio manager at T Rowe Price.
While other major economies are tightening policies, benign inflation in China allows room for monetary and fiscal expansion in 2023, he adds in a Dec 8, 2022 note. “We think China is in a unique economic cycle and we expect corporate earnings to accelerate meaningfully in 2023.”
In recent weeks, China has made a clear turn in its zero-Covid-19 policy, says Zheng. “While it could be a bumpy journey over the next few weeks, China is ready to move on from Covid-19 in one to two quarters.”
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Zheng believes the reopening will likely provide a major boost to domestic consumption and private investment. He also expects China’s property industry to stabilise in 2023. “From a valuation perspective, Chinese equities are trading at a decade low, despite the recovery in recent weeks. This, combined with improving fundamentals, presents potentially attractive opportunities in the deep Chinese equity market,” he says.
China remains a fertile hunting ground for active investors, Zheng writes, as big names give way to up-and-comers.
We expect market leadership to broaden, and investors should look beyond well-discovered mega-caps to identify future winners … We also find ample opportunities in the industrials space that benefit from idiosyncratic drivers, such as companies that can accelerate the energy transition, as well as those in traditional sectors like shipbuilding and oil services.
AllianceBernstein’s experts agree that opportunities in China will look different in the next decade. “It’s no longer about finding hyper-growth stocks with double-digit percentage annual rates of return, but more about bottom-up research to seek out idiosyncratic ideas and companies with robust fundamentals,” they say.
Over 2,500 onshore China companies are not covered by analysts, and 522 companies have only one analyst coverage each, notes AllianceBernstein. “We view companies that are aligned with China’s policy focus on energy security and tech independence as potential beneficiaries.”
Chinese equities portfolio manager John Lim raised two examples of overlooked companies in a November 2022 media briefing. One is manufacturers of xanthan gum, a key ingredient in condiments and a lubricant used in oil drilling. Another is the publishing and media sector — in particular, sellers of assessment books and exam guides — which Lim believes are a defensive play amid China’s crackdown on exorbitant private tutoring.
China’s sectoral winners
China’s leaders have belatedly recognised that the bigger risk it faces is no longer Covid-19, but the growth imperative, writes Manraj Sekhon, head of Templeton Global Investments, in a Dec 15, 2022 note. “Party leaders are now refocusing their efforts on boosting growth and consumer confidence. This transition is critical given poor economic data and weak consumer confidence which culminated in the recent unrest over the uneven application of its zero-Covid-19 policies.”
China’s exit from its virus suppression policies will not be linear and Sekhon expects some reversals. “A rise in fatalities and strains on its hospital system are among the biggest risks it will face … Investors are likely to look through policy reversals to the real economic impact of reopening. The performance of other markets post-reopening provides a template for investors.” he says.
Sekhon expects 2023 to be favourable to emerging markets (EMs), reflecting their economic resilience and robust domestic demand. “China is likely to be a leader with 15% estimated growth and we expect a release of pent-up demand as it pivots away from its zero-Covid strategy to one focused on growth. A pick-up in earnings revisions in EMs would act as a confirmation of better times ahead for earnings and, in turn, equity markets.”
An open China could put some pep in the steps of investors. Over there, monetary conditions are more accommodative with relatively low inflationary expectations, writes Fidelity International’s head of Asia-Pacific equities, Marty Dropkin. “The big question for the first months of the year is whether the economy can start to perform. Unlike Europe, there is no energy crisis, and our base case is for a moderate and gradual recovery of growth as the year progresses.”
Among Chinese names, Dropkin thinks domestic earnings will improve, as should margins, against the backdrop of renewed investment in infrastructure. “We are positive on consumer staples, financials and healthcare, but in general, much has been discounted across the market.”
Jefferies sees plenty of growth but also plenty of competition among China’s auto sector.
Despite overall new electric vehicles (NEV) penetration still being on an uptrend, the honeymoon stage of early NEV adoption, in our view, has ended, with more fierce competition ahead considering the 84 new models coming to market in 2023 (compared to 50 in 2022) with internal combustion engine (ICE) carmakers and tech giants joining the EV race.
Jefferies’ top picks are BYD and Li Auto. “We favour original equipment manufacturers (OEMs) with product line-ups in blue ocean markets, advanced hybrid technologies and initiatives in overseas expansion. We think BYD will be the clear price-maker in the sweet spot mass market and a pioneer exporter to Europe in 2023. Li Auto is our favourite NEV start-up for its first-mover advantage in the hybrid market, precise product positioning and operational efficiencies,” say Jefferies’ analysts.
Meanwhile, China’s internet sector could see a “year of revival”, say Jefferies’ analysts. “We are positive on the 2023 internet sector outlook, in light of the reopening story and improving consumer sentiment. E-commerce and verticals are set to benefit from sector themes, followed by online advertising and gaming. Both revenue and earnings growth are important. We suggest investors look beyond near-term headwinds. Over the next few years, overseas game expansion, omnichannel and cross-border e-commerce are areas to watch.”
Top picks include Alibaba, JD, Meituan; logistics players ZTO and YTO; short-form video company Kuaishou; entertainment names Tencent, NetEase and TME; online freight platform FTA; AI solutions and applications providers Baidu, Weimob and WPS; and fintech provider QFIN.
Jefferies’ analysts are also “maximum bullish” on China’s telco sector. “China’s ‘LDD Triangle’ (localise, digitise and decarbonise) is not only a multi-year theme, but will likely be stepped up in 2023 driven by the need to generate ‘high-quality’ growth, counter the US chip ban, and quickly develop a sustainable domestic tech ecosystem.”
StarPower Semiconductor is Jefferies’ top pick, followed by Wingtech. “We believe StarPower has the best insulated-gate bipolar transistor (IGBT) technology among local players, its IGBT products have been adopted by most local auto OEMs. We like Wingtech’s power metal-oxide-semiconductor field-effect transistor business and its original design manufacturing business will likely be more stable than expected.”
Should Chinese authorities maintain a supportive policy stance, Chinese equities can deliver on market expectations of 14% earnings growth in 2023, says John Woods, Credit Suisse’s chief investment officer for Asia Pacific. This would be “far superior” to the 6% growth he expects for the MSCI Asia ex-Japan Index.
On a national scale, Credit Suisse foresees 4.5% y-o-y growth in China’s real GDP in 2023, up from 3.3% in 2022.
A key risk is the pace of the expected growth recovery in 2H2023, writes Woods in a Dec 19, 2022 note. “As experienced by other countries, the herd immunity process takes time during which healthcare systems can become overwhelmed. This is nowhere more true than in China, where authorities chose the path of lockdowns to avoid contagion. An overwhelmed healthcare system could delay the economic reopening. Additionally, the lack of fiscal flexibility in a still-concerning housing market without further demand-side policy stimulus could leave the property market vulnerable to tight liquidity conditions.”
India a 2022 investment darling
In a year marked by an unwelcome positive correlation between developed market equities and bonds, India equities offered a rare diversification opportunity for global investors in 2022, says Huzaifa Husain, head of India equities at PineBridge Investments.
The Indian economy has been growing steadily, drawing strength from its macroeconomic fundamentals and buffers, writes Husain. “Supported by time-bound and targeted monetary, regulatory and fiscal policies, the economic recovery against a volatile global backdrop has been broad-based and resilient. MSCI India outperformed the MSCI EM Index and the All Country World Index (ACWI) by double-digit percentage points, recording positive returns while the two other indexes remained in negative territory.”
From where does India draw its strength? Husain says domestic institutional investors’ flows have buffered foreign investor selling, lending stability and liquidity to the market. India also benefits from a growing middle class and gained momentum from digitalisation, urbanisation, consumption and improved infrastructure.
India also boasts a “strong banking sector”, notes Husain.
We expect corporate earnings in India to remain generally strong into the beginning of calendar year 2023. Balance sheets of companies are robust, with low debt-to-equity levels, while bank balance sheets have also seen a clean-up of past bad loans, leading to one of the healthiest net non-performing asset ratios in recent history. A strong banking sector is now able to provide businesses required credit at a healthy rate to support their growth.
Indian banks should continue to enjoy their sweet spot of healthy credit growth, better margins and controlled credit costs, which would support 20% CAGR in profit, write Jefferies’ analysts. The key challenge stays around softer deposit growth and tighter liquidity, they add.
“Our top picks are ICICI Bank and IndusInd Bank. ICICIB is progressing well on the beta-to-alpha trade and is well-placed to deliver 17% return on equity over FY2023–FY2024 and 19% earnings per share (EPS) CAGR over FY2022–FY2025. IndusInd Bank has delivered a successful turnaround in profitability and we believe a combination of better growth and stability should aid further re-rating,” say the analysts.
Can India sustain this momentum? While inflation has been above the central bank’s 6% upper target, Husain believes inflation remains more manageable in India than in other major economies. “India remains vulnerable to spikes in commodity prices, which could impact its current account and fiscal positions. However, India has created adequate room to manoeuvre using its currency reserves to withstand shocks, as witnessed after the onset of the war in Ukraine.”
The central bank’s currency reserves, while healthy, have fallen recently due to the strong US dollar, writes Husain. As at Oct 7, 2022, the reserve level was the equivalent of more than eight months of imports. “On the fiscal side, we are seeing a sustained increase in goods and service tax collections, which should help ease the pressure to expand the budget deficit. Moreover, borrowings are largely financed by domestic savings, which helps insulate the country from external events.”
Over the next several quarters, Husain sees opportunities in large-cap financial and auto companies that are priced at reasonable levels and companies that use global commodities, such as energy, which should benefit from falling energy prices and improving profitability.
India could also stand to gain from US-China technology decoupling, notes Citi Global Wealth.
“We envisage an ongoing drive to diversify and reinforce supply chains on both sides, with potential beneficiaries outside both China and the US. These include the trading partners of both G2 powers in Southeast Asia, as well as India and Mexico.”
Over the coming decade, potential growth in emerging Asia will be led by India, followed by Indonesia, Malaysia and the Philippines, say Citi’s experts. “While the potential growth in China is set to slow further as its population ages faster, its economic size of over US$18 trillion ($24 trillion) will still be an important market for others to rely upon.”
But valuations overstretched
India’s bull run faces its fair share of detractors too. While Credit Suisse’s Woods expects growth momentum to continue in 2023 leading to double-digit earnings growth, India is the most expensive market in the region following strong performance in 2022. “Therefore, we see limited upside from current levels in the near-term,” he says.
His team at Credit Suisse foresees 5.8% y-o-y growth in India’s real GDP in the FY2023 ending March 31, 2024. This is down from 8.3% in FY2021 and 7.1% in FY2022.
Indian equities are trading around 30% higher than their long-term averages, or 21x forward earnings. This is significantly higher than the broader MSCI World index, writes Stéphane Monier, chief investment officer of Lombard Odier Private Bank, in a Jan 3 note.
Consensus expectations point to growth in earnings of more than 15% in both 2023 and 2024. At the sectoral level, India will continue to benefit from its strong industrial focus on digitalisation. However, Indian equities’ valuations remain high for now and so look less appealing.
Schroders’ India investment specialist Jigar Gandhi agrees. “The Indian economy and stock market held up relatively well in 2022 but challenges are building and valuations appear high.”
The MSCI India index returned –7.4% up till the end of October 2022, outperforming the MSCI EM index by 22%. Gandhi notes in a Dec 14, 2022 report that India is now the second largest weight in that index, comprising 15.55%, and it is the 10th largest in the global MSCI ACWI, at 1.6%.
“India has overtaken the UK to become the fifth-largest economy and according to some reports, will become the third-largest in the next 10 years if the policy stance and focus on growth stays on track. This is a long runway of growth and provides healthy prospects for the equity markets,” notes Gandhi.
Citing International Monetary Fund (IMF) estimates, Gandhi says the Indian economy will grow 6.1% in real terms, beating other large economies like China (4.6%) and the US (1.0%) in 2023. “This is largely due to growth in a strong domestic-oriented economy where exports are only 13% of total GDP,” he adds.
Echoing PineBridge’s Husain, Gandhi notes that domestic fund flows have kept the Indian equity market resilient. However, sectors with global linkages like metals and information technology continue to see earnings downgrades in anticipation of a global economic slowdown. “Even some domestic consumption sectors are seeing slower-than-expected demand and margin recovery,” he says.
Thus, Schroders’ Gandhi urges investors to curb their enthusiasm surrounding Indian equities. “Results, management commentary and guidance announced by mid- and small-cap companies are indicating that the valuations in these segments may be stretched. India is currently trading at historically high premiums of over 80% to other emerging markets. This is a key risk in case of any shift of sentiment and liquidity to other markets.”
Photos: Bloomberg
