China: Is its equity market oversold, or an opportunity to invest?

Christopher Ching

MA Financial Group

With concerns around global economic health resulting from rising inflation and interest rates, continuing economic disruption from COVID-19, and Russia’s military action against Ukraine, equity markets across the world are down.

China’s equity market CSI 300 is down 19.2% since the beginning of this year, compared to -15.1% for the S&P500 and -3.3% for the S&P/ASX200.1

Russia and COVID-19 concerns – are they ‘overdone’?

For China, market concern is centred around two main aspects:

  1. Russia’s invasion of Ukraine and the spill over effect on China
  2. COVID-19 imposed lockdowns in major cities including Shanghai.

It may well be that these concerns have been ‘overdone’.

Spill over effect from Russia Ukraine conflict

Many have drawn parallels between Russia and China and the possible economic fallout should China suffer decoupling from global markets as Russia has.

China, accounting for 18% of global GDP versus Russia’s 3% and being the largest exporter in the world, makes cutting ties with China easier said than done.

Although the rhetoric has ramped up as political tensions heightened, there has been no evident shift when it comes to actual trade.

COVID-19 lockdowns

On China’s COVID-19 situation, Shanghai has been under lockdown since late March 2022 . Being a metropolis generating over 3.5% of the country’s GDP the lockdown has unsurprisingly resulted in relatively weaker current economic data.

As of 17 May, Shanghai reached their internal target of three consecutive days of no new COVID-19 cases within the broader community, allowing the most stringent of restrictions to be loosened. Already, Tesla’s Shanghai Giga factory is back online along with other manufacturing plants.

Many believe the worst of the lockdowns may be over and the return to normality will only increase from here on, albeit with bumps along the way.

With the 20th National Party Congress to be held later this year, the government will do its utmost to ensure as much of the economy is back to normal and capital markets are functioning well if not riding on positive sentiment to ensure a smooth transfer for the next generation of China’s leadership.

Key aspects making the case for investment in China

In addition to these factors, there are three broader aspects that may add to the case for investment in Chinese equities:

  1. Policy divergence from the West
  2. Attractive valuations
  3. Chinese equities are substantially under-represented by the market and index providers.

China’s accommodative monetary stance

Contrary to the US’ monetary tightening stance, China is embarking on accommodative monetary policy settings.

In addition to front-loading fiscal expenditures, the State Council’s Financial Stability and Development Committee pledged to actively roll out accommodative policies in various industries that are conducive to the market. On 24 May, the State Council stepped up tax relief for Small to Medium Enterprises (SMEs) by 140 billion yuan.

In addition, on 25 April the People’s Bank of China (PBoC) cut various borrowing rates including the required reserve ratio (RRR). These accommodative policies will be conducive “for the high-quality development and supply-side structural reform.”

It is expected that infrastructure, the digital economy, and green initiatives will receive further policy boosts in the future – areas where we see long term potential for China’s new economy.

Attractive valuations

We believe the market has priced in much of the downside risks.

The CSI 300 is now trading at 11.7x forward PE; one standard deviation below its three-year historical average.

The price corrections year to date have, in our view, made selected sectors and companies attractive for long term investors.

With the excessive selloff in the market partly driven by non-economic factors, our investment team is starting to deploy more capital into high-quality companies in oversold sectors.

China is under-represented and under-allocated

Finally, Chinese equities are still substantially under-represented by the market and index providers.

Currently, China accounts for only 3.47% of the MSCI AC World Index (ACWI), with onshore listed A-shares comprising an even smaller allocation.

With China representing 18% of global GDP and having the second-largest stock market in the world by market capitalisation, index providers simply must adjust China’s relative exposure to adopt a more true-to-form representation of the economy.11

With full inclusion, Chinese equities may comprise over 40% of the MSCI Emerging Markets Index and 6% of the MSCI ACWI.12

This presents an attractive opportunity to allocate into China before both passive and institutional investors start adjusting their portfolios to reflect these benchmarks.

Beyond this, the diversification benefit and potential for alpha generation in a large inefficient market cannot be ignored by any truly diversified portfolio.

Access the fastest growing consumption story in the world

Long gone are the days of viewing China as a low-cost manufacturing hub. To learn more about gaining exposure to the fastest growing and most diverse consumption story click to FOLLOW button to be notified when I write a wire or visit our website.

........
1 FactSet, total return from 31 Dec 2021 to 13 May 2022. 2 Statista, 2022 < https://www.statista.com/statistics/270183/countries-with-the-largest-proportion-of-global-gross-domestic-product-gdp/> 3 Bloomberg 17 May 22 4 https://www.bloomberg.com/news/articles/2022-05-16/shanghai-hits-easing-goal-of-three-days-without-community-cases 5 ChinaAMC and Reuters 11 May 22 6 People’s Bank of China, 4 May 22 < http://www.pbc.gov.cn/en/3688110/3688172/4437084/4546950/index.html> 7 The State Council, People’s Republic of China, May 24, 2022. 8 People’s Bank of China, 15 Apr 22 < http://www.pbc.gov.cn/en/3688229/3688335/3730270/4532114/index.html> 9 MSCI, Paving the way to China, 2014. 10 MSCI ACWI, end April 2022. 11 Statista, 2022 and Securities and Futures Commission, 30 March 2022 12 China and the future of equity allocations, MSCI, June 2019. Livewire gives readers access to information and educational content provided by financial services professionals and companies ("Livewire Contributors"). Livewire does not operate under an Australian financial services licence and relies on the exemption available under section 911A(2)(eb) of the Corporations Act 2001 (Cth) in respect of any advice given. Any advice on this site is general in nature and does not take into consideration your objectives, financial situation or needs. Before making a decision please consider these and any relevant Product Disclosure Statement. Livewire has commercial relationships with some Livewire Contributors.

Christopher Ching
Investment Specialist
MA Financial Group

Christopher has over 10 years financial services experience and is responsible for the promotion of equity strategies of domestic and international equities within the asset management division. He was previously at Aberdeen Standard Investments...

I would like to

Only to be used for sending genuine email enquiries to the Contributor. Livewire Markets Pty Ltd reserves its right to take any legal or other appropriate action in relation to misuse of this service.

Personal Information Collection Statement
Your personal information will be passed to the Contributor and/or its authorised service provider to assist the Contributor to contact you about your investment enquiry. They are required not to use your information for any other purpose. Our privacy policy explains how we store personal information and how you may access, correct or complain about the handling of personal information.