What to do with China equities?
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A common topic clients brought up during this year’s annual outlook roadshows was what to do with China and Hong Kong equities. After three consecutive years of negative returns, MSCI China has remained on the downtrend so far this year. Patience is required as China’s policymakers shift focus to ensuring quality growth, but the continued stock market downtrend reveals a pressing need for coordinated policy support to restore market confidence. We believe that time is not too far away.
No 'Japanification' of China
Raymond Cheng
Some investors draw an analogy between China’s current economic conditions and Japan’s “Lost Decades,” when Japanese companies and households faced a surge in liabilities that surpassed asset values after the property and stock market bubble burst. We disagree with this analogy.
Admittedly, China is experiencing a similar magnitude of correction in capital markets. MSCI China, as an example, has tumbled over 60 percent since 2021, though this is not an index to which mainland Chinese investors have large exposures. Mainland investors worry more about A-shares, represented by the CSI 300 Index, which has fallen close to 45 percent since the high in 2021.
Also, unlike Japan, where real wages have plummeted since the stock market bubble burst, real income has grown in China. From the consumer spending standpoint, China’s retail sales growth slowed to around 7 percent in 2023, although that compared favorably versus the stagnant, if not downward, consumption trend in Japan during the Lost Decades.
Most importantly, excess net cash deposits in China have soared to 20 trillion yuan over the last two years, a stark contrast to Japan which saw negative net asset values.
While the situation is not as dire as the Lost Decades in Japan, rising savings in China signal a severe erosion of confidence. This has slowed or halted capital spending growth at the corporate level and consumption upgrades by the middle class. The latter is particularly notable, as big bulk-discount stores and e-commerce platforms targeting price-elastic consumers have gained popularity.
This phenomenon is spilling over to Hong Kong residents, many of whom have seen their net wealth dwindle, especially with the downturn in the property market, and are flocking to Shenzhen for a better value-for-money consumption experience.
Coordinated policy expected
As China’s A-share market has increasingly caught up with the weakness of the Hong Kong Hang Seng Index, Chinese authorities have taken notice and followed through with some forceful measures lately. The People’s Bank of China announced a 50 basis points cut in banks’ reserve requirement ratio effective Monday as part of an effort to boost liquidity to revive growth.
Meanwhile, media reports suggest authorities are considering a market stabilization fund of RMB2 trillion to support the onshore equity market. If confirmed, this fund would exceed the magnitude of the last market-boosting measure in 2015. Coupled with increased insider buying of high-profile listed companies, this should stabilize the stock market and revive investor sentiment.
A well-coordinated policy basket would be incomplete without addressing structural issues and fostering the development of strategically important sectors. To fix the property market issues, a framework is needed to provide cash-strapped mainland developers with the liquidity needed to secure the delivery of pre-sold homes. We await clarity on supportive measures towards developers to restore confidence in the property market.
To strengthen China’s long-term positioning, we hope authorities will roll out more nationwide measures to support strategically important industries, such as digitalization, semiconductors, automation, EV supply chain and clean energy. Many leaders in these industries are listed on the A-shares market.
We see more room for further monetary and fiscal loosening. This makes sustainable high-dividend payers in the offshore China market, such as those in the communication services sector, attractively valued, with dividend yields in high single digits.
Lessons learned
China is pursuing a path of its own in financial reforms, which will inevitably lead to surprises. Nevertheless, the bar for positive surprises for investors is very low, given the extremely inexpensive equity market valuation compared with China’s own history and emerging market peers. Diversifying into equity sectors that are aligned with policymakers’ priorities, such as technology, communication services and discretionary consumption, should help investors outperform the broader market and mitigate risks.
The likely dispersion between various sectors and stocks means China’s equity market is particularly attractive for stock pickers and active management, including long-short investment strategies. These should help investors better navigate the evolving geopolitical and policy landscape.
Raymond Cheng is chief investment officer for North Asia at Standard Chartered Bank’s wealth management unit.