In brief

• The Chinese authorities have acknowledged challenges undermining market sentiment and pledged to address them
• COVID-19 and economic stimulus should be relatively quick to be implemented
• There is no magic wand to boost investor confidence, but this is an important step to support Chinese equities

The Chinese equity markets, both onshore and offshore, have struggled in 2021 and 1Q 2022. A combination of factors have contributed to this challenge. On March 16, the State Council’s Financial Stability and Development Committee has acknowledged these concerns and pledged to address them. This helped to boost market sentiment in the short term. The key would be to follow up with concrete actions, and here we discuss what we should watch out for investor confidence to improve.

On the latest round of COVID-19 outbreak, the authorities have placed more emphasis on balancing between controlling the outbreak and limiting the economic impact from these measures. This does not mean the zero-tolerance measures would be abandoned in the near term, but there could be more policies tilting towards keeping factories in operations and reducing the lockdown period. For example, some restrictions were lifted seven days after Shenzhen went into lockdown. We continue to monitor the infection numbers both in terms of possible peak but also the breadth of new cases across the country. The zero-tolerance policy could see more room for change once the government sees the public are better protected by immunization or effective treatments.

Meanwhile, we will also expect to see reductions in lending rates and reserve requirement in due course to boost growth. The key to watch is credit growth, which has yet to respond to previous rounds of monetary loosening. The benefit of fiscal stimulus is that it could provide a more immediate and more predictable boost to the economy. The Ministry of Finance has already announced to cut income tax for small firms from 25% to 20% from 2022 to 2024.

The authorities have also pledged to manage the property sector’s systemic and financial risk. This could be focusing more on making mortgages accessible to home buyers and at cheaper rates. Direct support or bailout of troubled property developers does not look likely at this point.

On potential delisting risk of American Depository Receipts (ADRs) issued by Chinese companies, the committee mentioned that it is working with the U.S. regulators with some progress. Meanwhile, media reports said that the Chinese regulators are looking into which financial audit information can be disclosed to foreign regulators. 

Exhibit 1: Investors’ concerns have prompted valuation de-rating in Chinese equities
MSCI China: Forward P/E ratio 

Source: Bloomberg, MSCI, J.P. Morgan Asset Management.
Price-to-earnings ratio based on next twelve months earnings estimates. Dividend yield based on next twelve months dividend estimates. Price-to-book based on trailing 12 months book value.
Guide to China. Data are as of 28/02/22.

Then we need to observe whether the U.S. regulator would be satisfied with such disclosure. Meanwhile, we can expect more of these companies to look for dual or secondary listing in other markets, such as Hong Kong, as a back up plan. Since the U.S. is the largest and deepest financial market in the world, being delisted there could affect market liquidity of these companies’ stocks. However, in the long run, we see the corporate fundamentals to be a key factor in driving return and delivering shareholder value.

Another challenge weighing on Chinese equities have been regulatory reforms, especially on internet companies. We don’t expect the authorities to make a U-turn on regulating these companies’ business practices, especially monopolistic behavior or abuse of their market leadership to disadvantage employees or small businesses. The committee has pledged to be more transparent and predictable when introducing regulations. It remains to be seen how this would be executed in practice.

Investment implications

Although the Financial Stability and Development Committee’s comments provided some much-needed relief to the Chinese market, more concrete policies and results are needed to address investors’ skepticism and improve confidence.

Amongst all these challenges, containing COVID-19 and implementing economic stimulus via various administrative measures could be the quickest to achieve in the next two to three months. Admittedly, Omicron’s ability to spread could mean infection numbers may stay elevated in the near term, but experience in other economies has shown that each wave typically subsides in two to three months. This could be shortened with China’s stringent containment policy, combined with its track and test capability. Of course, stronger credit growth and more fiscal stimulus are needed to boost economic growth.

On regulation, the government will have to demonstrate being predictable and transparent when making changes in real life, and this could take time. Financial performance in quarters ahead would help investors to determine how these rule changes impact their long term earnings potential. Meanwhile, there are sectors with policy tailwinds that investors can consider. This includes areas such as renewable energy and decarbonization, as well as consumer goods and services that benefit from stronger income growth for the lower income group.

Whether Chinese companies could avoid being delisted in the U.S. exchanges is harder to predict since this would involve the reaction and requirement from the U.S. regulator, as well as the concessions made by the Chinese authorities. This implies companies that have made contingency plans to be listed in a second market are in a better position to weather through volatilities. 

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