Chinese equities have severely lagged behind the global market so far this year. The MSCI China Index has been broadly flat since January compared to a rise of around 13% on the MSCI Global Index. It follows substantial outperformance of Chinese stocks last year when the MSCI China Index soared by approximately 28% compared to 16% on the MSCI Global Index.
Chinese stocks have been held back by a variety of factors in 2021, including the initiation of monetary tightening measures in China, credit stress, additional regulation, and continued cool relations with the US. One of the biggest contributors to the MSCI China benchmark is e-commerce giant Alibaba, which is down by around 10% since the start of the year.
Attractive entry points
But some are optimistic about the outlook for Chinese equities. Although there is potential for continued volatility in the equity market, China is implementing a credit squeeze against the backdrop of an accelerating global economic recovery.
“Stock volatility is providing what we consider to be attractive entry points into specific sectors and companies, particularly when compared to international markets,” comments Rob Mumford, investment manager at GAM Investments.
President Xi hosted a politburo meeting on 30 April, with the overarching message being to maintain the status quo. However, Mumford says the meeting’s emphasis on “house cleaning” in the form of supply-side reform and prevention of financial risks seems to imply a continued modest tightening in China’s monetary policy, which was first signalled in mid-January.
Overall, China appears well placed to outpace other global regions in the economic growth stakes, a factor that should provide some longer-term support for Chinese stocks. While it has begun removing monetary stimulus earlier than other regions, China stands to profit from Joe Biden’s landmark plans for US fiscal interventions. Biden pushed through a $1.9tn financial relief programme early in his presidency and tabled a further $2tn government spending plan for infrastructure alongside a $1.8tn social welfare plan. All of which followed the $900bn COVID-19 stimulus package that was signed into law by departing President Trump in January.
“Stabilising monetary and fiscal aggregates will generate a negative policy pulse; while this is a marginal headwind it should not stop China from generating world-leading GDP growth, which perhaps has a further upside given the various US stimulus plans. Recent revisions to GDP have been to the upside and although the leading internet platforms have seen downwards earnings revisions, earnings have been on a positive trend outside of this sector,” says Mumford.
He adds that the Chinese authorities intend to remain flexible. With an “uneven” recovery underway, China may even choose to selectively ease monetary policy. This could take the form of a prime loan rate cut, reserve requirement reduction or accelerated green bond issuance should domestic economic growth start to stray below the government’s target, which is set at over 6% for 2021.
The Chinese authorities have been heavily focused on the country’s property sector. They are trying to tame excessive speculation amid concerns that a growing bubble in the market could eventually burst. However, in recent months, attention has clearly shifted to internet platforms, with the government beginning to draw up regulatory guidance and restrictions about how digital companies should operate. China is in the early stages of increased internet platform supervision.
“While we have a positive long-term view, we see three overhangs near term on the large internet platforms under scrutiny. First, the new antitrust regulatory umbrella remains an uncertainty, particularly in the areas of separating business lines and customer data collection. We do not see visibility on the various factors in play becoming clear in the short term; therefore the restrictions, guidance and fines imposed so far cannot with certainty be deemed the end game,” says Mumford.
In April, China’s anti-monopoly authority imposed a record ¥18.2bn fine against Alibaba over alleged market abuse. Meanwhile, large Chinese internet platforms have also pledged to step up investment, especially in the community purchase arena. This has led to some significant earnings downgrades, just as year-on-year financial numbers are being compared to periods during which such platforms were buoyed by COVID-19-related restrictions that saw rocketing demand from stay-at-home consumers.
Nevertheless, Mumford views certain stocks exposed to China’s online and offline retail sector as attractive, especially with “high-quality consumption” being the key policy goal of China’s new Five-Year Plan.
He sees “deep value” in Chinese property and insurance-related stocks, with valuations in these sectors dipping below those seen during the global financial crisis. Companies in these areas have been coming under intense regulatory scrutiny for some time. Insurance reform, for instance, has been ongoing since 2018.
“In both cases, we see the reforms as long-term positives, particularly for larger, well-funded operators, those poised for a cyclical recovery and names underheld by investors due to market conditions last year, where strong growth stocks prevailed,” says Mumford on the property and insurance sectors.
Less of a threat
Along with the possibility that US interest rates could rise next year, US-China relations remain a risk to the outlook for Chinese stocks. On this front, however, the overall risk may have diminished compared to 2020.
“While tension in the relationship looks set to be an ongoing feature of global geopolitics at present from an equity risk standpoint, we see less of a threat versus the era of the Trump presidency,” says Mumford.
Although the Alaska-based meetings in March 2021 between officials from the US and China showed relations remain cool, Mumford sees President Xi’s subsequent agreement to join a US-sponsored meeting on climate change as encouraging. In May, the US also agreed to join a United Nations event chaired by China on global cooperation.
“These are just two examples which, for now, strengthen our view that while the US-China relationship is likely to remain difficult, it will be issue-based with certain areas more contentious than others,” adds Mumford.