There are still reasons which advocate that Chinese equities continue to play a diversification role for long term investors.
Global Market Strategist
- Despite China’s resilient GDP growth in 1Q 2022, monthly data in March weakened, indicating substantial pressure from the COVID-19 resurgence and lockdown measures.
- Further monetary and fiscal stimulus are expected to support the economy and mitigate recession risks.
- Investors are looking towards policy support to boost economic growth and take advantage of undemanding valuations.
Pandemic lockdown measures weigh on recent economic activities
China’s National Bureau of Statistics reported 4.8% year-over-year (y/y) real GDP growth for 1Q 2022 (4Q 2021: 4.0% y/y, consensus: 4.8% y/y), thanks to the strong growth in January and February. However, the latest round of COVID-19 outbreak has impacted economic activity in March, and poses challenges in 2Q 2022.
Consumption and real estate weighed on growth in March. When lockdowns spread across the country, retail sales dropped by 3.5% y/y while food services income was down 16.4% y/y. Despite the relaxation of property control measures, property sales declined by 13.8% y/y in floor area and 22.7% y/y in value, due to the lockdown measures and weak sentiment. There is a strong expectation that consumption and property sales could rebound when the lockdown measures are lifted. However, this depends on whether a prolonged lockdown measures would have a significant impact on income and wealth.
Momentum in fixed asset investment also slowed in March, with a y/y growth rate of 6.7% (our estimate based on year-to-date data) after a strong rebound in January and February (12.2% y/y). Though there was easing in property market controls and local government financing are improving, recent lockdowns and transportation disruptions in eastern China may have delayed progress in projects. Investment sentiment also weakened among the private sectors, with a slower growth of 5.7% y/y of private fixed asset investment in March (January and February: 11.4%).
Industrial production grew 5.0% y/y in March, roughly in line with the trend before the pandemic, although it was lower than the 12.8% y/y growth rate in January and February. If transportation bottlenecks sustain throughout April, factories will face increasing challenges in accessing supplies and delivering products, resulting in weaker growth in April.
Exhibit 1: China’s stock valuation at reasonable level after recent correction
MSCI China* forward price-to-earnings ratios
Stronger stimulus measures are expected
Besides weak economic data, urban unemployment rate rose to 5.8% in March from the previous reading of 5.5%, also pointing to the urgency for stronger policy supports.
The People’s Bank of China announced a 25bps required reserve ratio (RRR) cut across the board, with an additional 25bps cut for some small banks. This move brought down the weighted average RRR to 8.1% from 8.4% in December 2021, and a total of RMB 530 billion of loanable funds will be released. A loan prime rate (LPR) cut is also expected to cut funding costs for banks. We see an LPR cut as a more effective way to support the real economy, since it could help relieve the burden of existing debt for businesses which are losing income.
On the fiscal policy front, tax and government fee reductions are still the major tools to support the business sector. Direct fiscal transfers may be more powerful to save businesses and help households if lockdowns last longer.
Some investors are concerned that the current economic challenges and diverging monetary policy path between China and the U.S. could lead to capital outflow. This would depend on the speed of containing the outbreak, as well as the magnitude of economic stimulus. On exchange rates, the sizeable current account surplus should still be sufficient to maintain stability.
Chinese stock markets are under pressure from the recent lockdown measures. Sectors sensitive to the supply chain disruption, such as automobile, capital goods and semiconductors, have seen significant correction. That said, there are still reasons which advocate that Chinese equities continue to play a diversification role for long term investors.
As mentioned above, we expect adequate economic stimulus to be applied once the pandemic comes under control. This should help to improve investor sentiment. Secondly, Chinese authorities are still working with U.S. regulators to resolve the disclosure requirement for Chinese companies that are listed in the U.S. Signs of cooperation should help to relieve some pressure. Finally, Chinese equities continue to trade at inexpensive levels and the MSCI China Index still has forward earnings growth above 10% in 2022 and 2023. Active management remains key, and investors may favor sectors with policy tailwind, such as decarbonization and technology that could be developed to reduce dependence on imports.