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As the world focuses on the Russia-Ukraine war and the Fed’s hawkish moves, China is undergoing an important policy shift that might mean an inflection point for the market.
The Chinese market was volatile in early March. However, a speech by Vice Premier Liu He on March 16 eased investor concerns, and coupled with massive short-covering, the Hang Seng Technology Index rebounded.
The warmth from the central government halted panic selling, while Chinese stocks and bonds saw record foreign capital outflows in the first three months of 2022. For the first time since the tightening of regulatory measures at the end of 2020, the Chinese government has made it clear that it will “actively introduce policies that are favorable to the market” and maintain market confidence.
Importantly, Vice Premier Liu He also stressed that regulatory measures in the Internet industry need to be more coordinated, more transparent and managed as a whole so as not to hurt investment sentiment. At the same time, in order to achieve the economic growth target of “regarding 5.5%” in 2022, the government promised to increase monetary and fiscal support, boost credit growth and prevent and defuse real estate market risks.
In particular, we expect fiscal policy to play a bigger role. For small and micro enterprises with an annual taxable income of 1 million to 3 million yuan, the actual preferential tax rate will be reduced to 5%, and the government spending target will be regarding 13% higher than last year. At the same time, to support domestic economic activity, monetary policy will keep liquidity reasonably ample, rather than cut rates sharply — a prudent move once morest the backdrop of potentially aggressive future rate hikes by the Federal Reserve.
Upside potential
Chinese stocks (as measured by the MSCI China Index) are down more than 13% this year following tumbling nearly 23% last year. Therefore, the change in policy tone is highly anticipated by the market. For patient investors, we see opportunities in large tech companies with low P/E valuations and still solid earnings prospects. Even following the recent rebound, overall share price levels suggest that sentiment remains subdued and largely ignores the potential for innovative growth in Chinese companies.
In fact, we expect MSCI China to deliver solid earnings growth of 13% in 2022 and support mid-double-digit returns in this market. The government has said it will keep capital markets running smoothly, and share buybacks might add another boost to share price performance, especially as leverage at MSCI China components has fallen to a seven-year low.
Significant risks remain, but should be manageable
Still, investors will need to keep an eye on a number of major challenges facing China.
First, despite China’s rhetoric of fine-tuning its epidemic prevention policies, major economic centers such as Shenzhen and Shanghai have also imposed lockdown measures. A new round of travel restrictions might hamper a recovery in consumption, but the impact on production should be limited and short-lived.
Second, reports of defaults by real estate companies still make investors worried regarding credit risks, and more measures are needed to stabilize the real estate market. It is worth noting that mortgage interest rates in more than 100 cities have been lowered, and new regulations on pre-sale funds supervision accounts will also help ease developers’ cash flow problems.
Third, the lingering risk of Chinese companies being sanctioned by the United States due to the strengthening of Sino-Russian ties. If China offers limited support (like buying oil and grain at favorable prices), the U.S. may not care that much, especially if Europe continues to buy Russian energy. But the risk of sanctions might rise sharply if China provides military or technical assistance to Russia.
Finally, despite the recent positive comments made by the China Securities Regulatory Commission, the delisting of Chinese stocks is still a major concern. At present, the regulators of China and the United States are maintaining dialogue and consultation, and it is reported that large technology companies are preparing to disclose more comprehensive audit information. It seems possible that the two sides can reach a consensus, but even if not, the vast majority of Chinese concept stocks can still choose to conduct a secondary or dual listing in Hong Kong, which is interchangeable with stocks listed in the United States.
Where are the investment opportunities in China?
The above challenges remain variable and might lead to market volatility. But overall, policymakers appear to be slowing down on regulation, while policy is expected to ease. Risk sentiment in Chinese assets should improve in the coming quarters.
For short-term outperformance, investors can focus on sectors that benefit from fiscal stimulus and high commodity prices. This includes cyclical and value sectors such as energy, telecommunications, metal mining, and construction materials. Renewable energy operators are also expected to perform well.
From a strategic perspective, the increased focus on independent technological innovation and national security spending should benefit the smart infrastructure and cybersecurity sectors. Electric vehicle supply chains and the digital economy should also benefit from favorable policies.
Under the global risks and shocks, the Chinese market is not immune. Given the challenging overall environment, investors should hedge and diversify through alternative investments in their strategic asset allocation, including hedge funds, direct real estate and private markets. With global energy prices rising, interest rates higher, and inflation climbing, we recommend investing in commodity producers, financial stocks, and floating-rate securities such as U.S. senior loans.
(The author is the chief investment officer of UBS Wealth Management Asia Pacific. This article only represents the author’s point of view. Responsible editor email: tao.feng@ftchinese.com)
