A and H shares at decade lows. Why are investors are holding back?
Since China's 20th Communist Party Congress, a lot has happened and a lot is going to happen. How this all plays out is changing by the day.
After a 10 year power struggle, President Xi Jinping now has his own self-chosen cabinet. The immediate changes that followed appear to be focused on getting the China growth show back on the road.
- Zero-Covid policies resulted in consumption, investment and net exports plummeting to 30 year lows, along with real GDP.
- The transition from 'any growth' to 'common prosperity based growth' led to heighten regulations that stifled several sectors of the economy, including the (Financial) technology, internet and gambling sectors.
- Tighter regulations also brought the two decade long growth story to an end in the Chinese Property sector - back in July 2021.
Enter 16 measures to support the property market (sponsored by the People's Bank of China (PBOC) and the China Banking and Insurance Regulatory Commission (CBIRC).
Plus a further 20 measures to relax Covid control guidelines, sponsored by China's National Health Commission (NHS).
Plus the diplomatic efforts by President Xi Jingping to manage a geo-political balancing act that keeps China trading globally.
With 50% of China's employment (and GDP) driven by services (including tourism), free mobility is key to growth. But the result speaks for itself - no official numbers are being published on Covid infections levels - the images of Chinese hospitals brimming with people tell the story instead.
Both household and corporate debt remains higher than many developed markets. Unwinding this debt will also take time. Whilst households are once again building up buffers, consumer confidence remains low. And for some property developers, time is all they have before insolvency is inevitable.
For now, investors seem to be in wait and see mode, despite both H and A shares trading a decade lows.
Chinese Stock Markets Dropped. What Next?
With China’s 20th Communist Party Congress over, President Xi Jinping secured his third term. How will this impact on Chinese Stock markets?
On the Monday, the Hong Kong Hang Seng Index dropped 10% (the second largest one day drop), with reportedly 80% of the selling from EU/US investors. Simultaneously, US-listed Chinese tech groups in the Nasdaq Golden Dragons Index also plummeted 14%. Yet in almost parallel, China 3Q22 GDP came in 20% above consensus at 3.9% year-on-year.
Most agree that China is in a bear market. But would also concede that Xi Jinping's last 10 years have been successful. Over this period, China's growth in real income, retail sales and share of global economic growth have been 2x to 3x greater than the U.S..
However, many investors now point to the latest consolidation of Xi Jinping's power as dangerous. And that his focus will be on increasing domestic control and national security.
But there is also a cohort of Asset Managers closer to the markets (i.e. based locally) that see things differently to the asset managers allocating to Chinese Equities remotely (i.e. from other continents).
Whilst acknowledging the danger of diminished checks and balances surrounding Xi Jinping's power, they also see a politician at work. One that needs to remove political obstacles that have hindered the pace of common prosperity. And a new Politburo that is not just a team of followers, but of individuals that share his common vision. And who have the political skills to ensure the vision is fulfilled. Faster than has been previously possible.
And whilst some managers interpret the words "Chinese National Security" as a pseudonym for future heightened geo-political tensions with the U.S. over a range of running issues. There are others that argue the Western Politicians and CEO's are doing the same. Investing in clean energy, semi-conductors, electric vehicles, batteries and clean energy, as well Artificial Intelligence, Software and the Internet.
Are Chinese stock markets cheap? If there are signs that the Chinese Zero-Covid-Policy is relaxed and vaccination levels increase, markets may rebound fast, regardless of level of paranoia or realism investors attach to Xi Jinping's vision, across the globe.
Making Equity Portfolio's Efficient
Chinese Onshore Equities are probably one of the most under-appreciated diversifiers for adding uncorrelated returns to investors current portfolio.
Diversification has been tough of late with bonds and equities exhibiting co-integration. So the search is on for asset classes that can solve this problem. The research being performed inside RFPnetworks is not necessarily about mean-variance optimisation. It's focused on qualitative causality. Why is one asset class uncorrelated with the current portfolio basket. These insights are pulling investors towards the Chinese Equity onshore market as an underappreciated diversifier.
Perceptions on Chinese Equities are changing, albeit slowly. Accessibility barriers have lifted over the past 20 years: Starting with China joining the World Trade Organisation in 2001; introducing Qualified Foreign Institutional Investor (QFII) quotas; and the launch of Stock Connect.
But the fact remains that European and Western institutional investors portfolios are still significantly underweight China. Whether you look at this in terms of global market size, index representation, or on a World GDP or population share basis.
This could be a missed opportunity given cross-asset correlations today. Unlike U.S., European or some other Asian Equity markets, China's onshore equity market is not purely a play on global growth. This was the widely accepted view, but the reality today may be different.
Many of the underlying drivers of the Chinese onshore equity market are domestic and not global. Which is leading investor to acknowledge this causality as a potential portfolio diversifier. But most asset managers do not cover all of the constituents of the USD 7 trillion Chinese A-Share market. They lack a local research hub and analysts. So finding a manager that can build a Chinese Equity Onshore portfolio that is de-correlated from the global economy requires a customised solution and smarter sourcing across across this highly specialised investment manager universe.
China Is Difficult To Ignore
The Chinese Equity market may be cheap and too risky, but it is difficult to ignore. Especially now as markets show some early returns to growth.
China is rarely off the radar of Institutional Investors, but more recently for reasons that dissuaded new allocations: The regulatory crack-down on tech companies; a zero-covid policy that led to entire cities being shutdown, stiffling growth and supply chain fluidity; and volatile geopolitical tensions in the region. But there seems to be a renewed spark in interest as can be seen in the MSCI China Index, which increased around 20% between May and July.
Based on clicks and search queries on China, Institutional Investors seem to be focused on three things: Firstly, Chinese Government officials sentiment on economic growth; Secondly, how that growth is now being stimulated; And thirdly, how will that growth impact the global economy. Whilst US-China geopolitical risks seem to be on the increase, from an economic perspective, there are signs that Chinese Equity valuations may be on the rise once again.
Or put differently, can you avoid not to take a second look.
China stocks are slumping on news of rising COVID-19 cases in the world’s most populous country but that doesn’t negate their strong rebound in recent months. The MSCI China Index has still risen by more than 20% since early-May, according to Bloomberg, when it hit what now appears to be a trough. That is a remarkable recovery, given that the world’s second largest economy has been challenged this year by COVID-19 flare-ups – including one that led to a lockdown of Shanghai, home to the world’s largest seaport, in the spring – as well as continuing global supply chain constrictions and uncertainty around Beijing’s regulatory crackdown on technology stocks. Only a few months ago, those factors led some Western market-watchers to openly wonder if China had become “uninvestable.” So for those investors who rode out the downturn, the recent uptick in China stocks is surely welcome. The question, however, is whether the recovery is sustainable.
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