The China Briefing

It’s all about the “E” (earnings)

Please find below our latest thoughts on China:

  • Onshore and offshore China equity markets have behaved quite differently since the conclusion of the Party Congress.
  • At one stage, the MSCI China Index had fallen by 10% before rallying sharply. In contrast, the MSCI China A Onshore Index fell by around 5% at the low point and is now close to flat (2 Nov 2022, local currency).
  • The trigger for the market rally was a rumour – starting on social media in China - that a “reopening committee” had been formed to assess various opening-up scenarios.  
  • The market also received a boost after some local authorities approved a new inhalable vaccine, made by a Hong Kong-listed company called CanSino Biologics, which may be more appealing to sections of the vaccine-hesitant population. 
  • Whether there is any truth to this rumour or not, only time will tell. But what the reaction does show is the extent to which zero-Covid policies have been weighing on markets.
Chart 1: MSCI China A Onshore Index – decomposition of index returns

Source: Bloomberg, as at November 2, 2022

  • On the one hand, the lockdowns clearly limit people’s ability to travel and to move around. There have been examples of this in recent days – visitors to Shanghai Disneyland at the weekend had a longer stay than they bargained for in Space Mountain when the park was locked down after one guest tested positive. 
  • Over and above this, however, is the more psychological impact of the uncertainty. Consumption remains depressed. And savings rates, which were already high pre-Covid, have continued to grow further. 
  • The flipside to this, of course, is that when Covid policies are eased, there should be significant pent-up demand. 
  • It was only three years ago when it was commonplace to see queues of Chinese tourists at duty-free tax counters in airports around the world. Those days will come again as there remains huge appetite in China to travel and to experience the rest of the world.  
  • So where do recent events leave us in terms of the market outlook?  
  • Our view overall is that both onshore and offshore markets have discounted a lot of bad news. China A-shares are trading close to 11x forward PE and offshore China at less than 10x.2 In both absolute terms and relative to history, these are low levels.  
  • In addition, looking further out, the price-earnings-growth (PEG) ratios are well below one.3 Many quality growth stocks have derated significantly.   
Chart 2: MSCI China A Onshore Index – future Price Earnings Growth (PEG) ratio

Source: Bloomberg as at 30 September 2022

  • The key is the confidence level in the “E”. The current lack of confidence – and the associated market derating – has been the main factor behind the sustained weakness, especially for China A-shares.  
  • Things can change quickly, however – as events this week have demonstrated. It is only a matter of time before China starts to plot a course out of Covid.  
  • While we see upside potential in both onshore and offshore markets, our view currently is to favour China A-shares. Given the more limited options available to onshore investors, domestic equities are likely to respond quickly to signs of macro improvement. 
  • The situation for offshore China markets – where global institutions dominate the shareholder base – is more challenging. 
  • The outcome of the Party Congress appears to have been a big “reality check” for global investors.  
  • Although in practice the Congress has formalised what was already happening more informally in terms of consolidation of power, nonetheless recent market events demonstrate that the perceived level of risk associated with investing in China has clearly increased. 
  • And while geopolitical risks may ease a little once the US mid-term elections are behind us, nonetheless these factors are still likely to pressure valuations in the offshore market in a way that is less of a factor for A-shares.  
  • Our view on long-term growth themes in China has not changed as a result of the Congress. We expect a continued push to enhanced domestic capabilities in areas such as technological development, the transition to green energy, and food security. And in order to support the funding of China’s growth aspirations, we also anticipate further reform and enhancements to the infrastructure of China’s capital markets.  

1 Source: Bloomberg, 2 November 2022
2 Source: Bloomberg, 2 November 2022
3 Source: Bloomberg, 30 September 2022

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