China’s economy remains challenged but there are reasons to have long-term exposure to its equity markets, in our opinion. We don’t necessarily expect a monetary or fiscal bazooka by China’s government however we do think there are some specific catalysts for potential growth and recovery as well as some key traits and broad initiatives that could provide positive benefits for long-term investment strategies.
China may be closer to finding its economic footing. In the first few months of the year, industrial activity strengthened and recruiters reported some green shoots in hiring. Confidence remains weak and people are worried about the property market but they are spending—particularly on mass market ecommerce platforms and discretionary areas like dining, travel and entertainment. Business owners tell us the economy is tough but they trying to adapt. Some are successfully finding opportunities in overseas markets and others are focusing more on efficiency and profit margins rather than top line growth.
The government’s National Team of equity buyers has added some stability to the market. More than two trillion renminbi has been set aside for national entities to buy mainland stocks and a further 300 billion renminbi has been earmarked to invest in onshore equities. This intervention helped arrest some of the steep declines in China’s markets that we saw at the start of the year and has provided a platform of stability. We see this initiative continuing to make an impact as the year progresses.
Earnings growth is one of the most important drivers for China’s markets, in our view. We think earnings downgrades have probably run their course. It’s expected that this year’s earnings growth will exceed that of 2023, which was around 10% according to consensus estimates. In our view, that adds a buttress to market valuations. It also provides a platform for greater earnings growth in future years and nurtures the potential for positive surprises on the upside.
Appealing valuations. Chinese equities are on average priced at about 10 times 2024 earnings. It is a level which, in our view, provides a potential buffer against magnified or unforeseen risks, be it additional challenges in the housing market or intensification of geopolitical tensions. These valuations levels are also sensitive to upside drivers such as earnings growth.
Capital market reforms. China’s Nine-Point Guideline plan, introduced in April, could have a meaningful impact on corporate governance. We think the plan, which includes measures to encourage dividend payments and improve the quality of new stock offerings and shareholder rights, may help narrow valuation discounts between Chinese stocks and Asia stocks. Part of our reasoning is that we are seeing moves toward better governance and capital efficiency on the ground. In our company meetings we have seen some management teams shift the focus of their key performance indicators (KPIs) from traditional metrics of size and revenue growth toward profit growth or “quality growth”, as well as to efficiency targets and returns on invested capital.
Funding to help local governments buy up excess inventory from property developers and moves to cut down-payment requirements for homebuyers and loosen limits on mortgage rates could be the start of a long road back for China’s housing market. These measures could help balance supply and demand and restore some buyer confidence. Although fiscal support is still relatively limited, the direction is positive, in our view, and we think the embracing of these initiatives by tier 1 cities like Shanghai bodes well.
China’s third plenum. Announcements made at the Chinese leadership’s third plenum in July could positively impact market sentiment and the prospects for economic recovery. The gathering is one of seven in the five-year cycle of the party congress and this mid-cycle forum has been a platform in the past for China’s Politburo to introduce economic measures and reforms. At the meeting next month, media reports suggest that the government may unveil initiatives which could include more efforts to stimulate the property market, new plans for fiscal spending or macro inducements like interest rate cuts. We remain alert to developments that may have a positive or a negative effect on sentiment.
Longer term. Chinese companies could be the beneficiaries of a global easing of interest rates should the U.S. Federal Reserve embark on a rate-cutting cycle. Looser financial conditions globally would support a pickup in China’s cyclical industries, such as construction, financial services, autos and consumer discretionary. Thematically speaking, and with more of a long-term lens, we also believe innovation in artificial intelligence (AI), and global advances in technology hardware and semiconductors, will create investment opportunities in China. We are aware, however, that this is an area in the crosshairs of U.S.-China tensions and has the potential to be exposed to volatile market sentiment.
Exploiting potential catalysts
It’s important for investors to recognize the differences between China’s mainland, or A-shares, market and China’s offshore markets. Onshore equities are more exposed to China’s real estate sector and domestic consumer markets while offshore equities carry more digital and ecommerce platforms, health care, financials, and consumer discretionary businesses. In the offshore market, we are seeing better earnings-per-share (EPS) recovery as companies improve capital efficiencies and implement stock buyback programs.
Our consideration of growth agents and catalysts in China’s markets remains mindful of the geopolitical headwinds China faces. U.S. tariffs and curbs on Chinese exports and tensions between the two countries are an ongoing challenge to overall sentiment. While we think the potential outcomes of the U.S. presidential election have been factored into valuations, we are cognizant of avoiding companies and sectors that could find themselves negatively impacted.
China’s economy is also far from out of the woods. Its producer price index (PPI) is still negative though it has improved from last year. While a negative reading is beneficial to manufacturers on the cost side, a positive reading would signify that the internal growth engines of China are getting back to something like a healthy condition.
Big things can happen in China overnight and they often do. To successfully exploit catalysts of recovery and growth in China, investors need to be nimble and active and, at the same time, stay focused on the fundamentals, the qualities and the prospects for companies and sectors.
IMPORTANT INFORMATION
The views and information discussed in this report are as of the date of publication, are subject to change and may not reflect current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investment vehicles. Investment involves risk. Investing in international and emerging markets may involve additional risks, such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility and limited regulation. Investing in small- and mid-size companies is more risky and volatile than investing in large companies as they may be more volatile and less liquid than larger companies. Past performance is no guarantee of future results. The information contained herein has been derived from sources believed to be reliable and accurate at the time of compilation, but no representation or warranty (express or implied) is made as to the accuracy or completeness of any of this information. Matthews Asia and its affiliates do not accept any liability for losses either direct or consequential caused by the use of this information.
A message from Advisor Perspectives and VettaFi: To learn more about this and other topics, check out our most recent market outlooks.
© Matthews Asia
Read more commentaries by Matthews Asia
