Investment Institute
Monthly Market Update

China monthly update: Chinese equities - can the strong momentum continue?

  • 19 January 2023 (10 min read)

Full transcript

Aidan: Hello, welcome to our monthly video, my name is Aidan Yao. I’m the senior emerging Asia economist at AXA IM.

First of all, please allow me to wish our viewers a happy and prosperous year in 2023.

In this video, I’m glad to have my colleague, William Chuang – our senior equity portfolio manager – back to discuss his view on the Chinese equity markets.

Will, welcome back!

Will: Thanks for having me, Aidan!

Aidan: We have seen a tremendous turnaround of Chinese equities in the last few months. And the rally has continued on a very strong momentum this year. In fact, the Hang Seng Index (HSI) has so far been the best performing market in 2023 with A-shares not far behind it. What in your view has driven such a stellar comeback of the markets after their disappointing performance in the last two years?

Will: Well, when we last sat down in Aug., I had said the market was in a holding pattern, waiting for changes to occur. Since then, everything has changed. This is what has driven the 50% rally we have seen in Chinese equities since the end of October. There are a few factors at play here:

First, through the fall, COVID situation was getting worse and mobility restrictions were being implemented across multiple cities. Then we had the Party Congress in October where the leadership reshuffle happened. The consensus view was that China will stick to the same policies as over the past couple of years which had been a huge drag on the economy, while we were arguing that pragmatism will win the day.  Basically, the expectation could not have been lower and sentiment could not have been any worse. So when Beijing started to dismantle the entire zero-COVID apparatus built up over the past 2 years, it caught everyone by surprise. Pragmatism was not something people had factored into their China outlook.

Secondly, we started to see more meaningful intervention in the property sector, starting with the 16-point plan announced in mid-November. Subsequent policies showed that China wants to tackle the supply side of the equation and put a backstop on financial issue of developers but guaranteeing liquidity. Now the focus has shifted to the demand side and we’ve seen the implementation of flexible mortgage rates as well as the removal of home purchase restrictions.    

IF zero-COVID and property sector were the 2 main overhangs on Chinese equities, China has moved quickly to address both issues over the past 2 months. This is why the market has behaved as such. The key driver being a sudden shift away from rock bottom expectations.       

So Aidan, do you see the current market optimism justified by economic fundamentals, and are there any risks on the horizon that could derail this rally?

Aidan: Insofar as near-term conditions are concerned; all eyes remain on the COVID wave. Unfortunately, the termination of official data has left the market flying blind on where we are along the infection cycle. But there is plenty of anecdotal and survey information suggesting some cities and regions have already passed the peak wave, even though the absolute level of infections remains elevated.

And this is reflected in economic data. The official monthly data paints a bleak picture of disruption following the policy pivot. But if you look at high-frequency daily data on traffic, mobility, freight volumes and house sales, there are signs of activity bottoming in late December and a recovery has taken hold thereafter. Hence, there are lights at the end of the tunnel, which I think help to reinforce the market’s optimism that what China is facing is a transient shock, and a recovery is lying beyond the near-term struggles.

In terms of risks, I think we need to monitor the COVID situation during the lunar new year. In particular, the spread of the virus from cities to rural areas as migrant workers return home for holiday could create pressure on the health system there which is not well-equipped, and delay the return of migrant workers to cities if they have to take care of the sick. The latter could postpone the anticipated recovery and upset the market.

So Will, what’s your outlook for Chinese equities in the reminder of this year? How much upside do you see in the markets after considerable gains in recent months? And sector-wise, where do you see opportunities and how should investors position for them?

Will: That’s a great question. We’ve gone back at looked at MSCI China over the past decade and noticed two things.

First, peak-to-peak cycles last typically 3 years.  We saw that in 2011-2013, 2015-2018, and 2018 to 2021. If historical pattern holds, the current upcycle should take us into early 2024. While we may see short term profit taking, my view is the structural uptrend should remain intact.

Second, MSCI China has corrected by over 60% since early 2021 through to October. Following the last two corrections of comparable scale, Asia Financial Crisis and the Global Financial Crisis, the market returned over 150% over the following 12-18 months.

Given the earlier than expected rebound from cyclical trough, we are quite positive on Chinese equities on positive earnings revision opportunities. We continue to favor the clean energy space and think this is the year we see a strong ramp in renewable energy installation. We also like consumption plays after basically 2 years of depressed demand due to on again off again COVID restrictions. Leisure travel segment could rebound faster than expectation.  

Aidan, is that market view consistent with your economic outlook? Has the COIVD policy U-turn and other developments lately led you to reconsider your growth and policy expectations for 2023?

Aidan: They have for sure. Even through we made the right call on the direction and starting point of the COVID policy shift, we were clearly too timid on the speed and scale of changes. Relative to our expectation of a gradual and step-by-step reopening process, what has transpired was clearly a surprise.

And the implications are twofold. In the near term, the disruption to the economy and society is greater than forecast due to the lack of medical and mental preparation. This is already reflected in the poor November and December data, and I think the pressure will persist in the first few months of this year. So there is a downside risk to our Q1 growth forecast.

However, the faster reopening also implies the subsequent recovery could be frontloaded and may be of a stronger momentum than previously thought. We think this will be led by consumption and services – the two sectors that have been suppressed more by COVID restrictions than others. And we see Beijing’s policy remain accommodative to nurture this recovery, although the improved policy transmission probably renders the need to add further aggressive stimulus.

Given these uneven impacts, we have not yet changed our 2023 growth forecast – at 5% – which still sits above the consensus. However, the balance of risks has certainly shifted, from the downside before the policy pivot to the upside now.

So overall, I’d say our macro outlook is consistent with the optimistic expectation currently discounted by the markets.

Thank you, Will for coming back on the show to share your view on what lies ahead for the Chinese markets.


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