Domestic monetary policy normalization should be seen in the context of improvements in the domestic economy, and subsequently earnings recovery.
Marcella Chow
Global Market Strategist
Listen to On the Minds of Investors
Chinese equities ended lower last week with CSI 300 and MSCI China falling 13.8% and 13.3% respectively since February 17 due to a slew of global and domestic factors (Exhibit 1).
Rising U.S. Treasury yields continue to pressure risk sentiment. 10-year Treasury yields surged past 1.75% last Thursday due to U.S. economic overheating concerns amidst the backdrop of rising inflationary pressures. In particular, this was supported by last Thursday’s release of Philly Fed manufacturing survey print, which hit the highest level since 1973, with the prices paid component of the survey rising to the highest since 1980.
The stronger economic outlook in the U.S. and expectations of further stimulus have led to upgraded growth forecasts as other regions of the world are being downgraded. Meanwhile, the resurgence in COVID-19 cases in Europe and the troubled roll-out of vaccines across the continent have led some European countries to re-introduce or extend mobility restrictions for another month.
Profit taking may have been another source of selling pressure in Chinese equities. The share prices of some crowded trades have risen notably year-to-date.
Moreover, investors remain concerned about China’s monetary policy normalization and are worried about risks of preemptive tightening. We continue to expect the policymakers will likely opt for gradual policy normalization. So far, March’s loan prime rates (1-year at 3.85% and 5-year at 4.65%) have stayed unchanged for 11 months in a row while 1-year medium-term lending facility and repo rates have also been left unchanged. People’s Bank of China governor Yi Gang spoke at the China Development Forum over the weekend, assuring the market that China still has room to pump liquidity into the economy while keeping its leverage ratio stable.
Potential further regulatory changes facing tech industry leaders also continue to pose uncertainty to the market and related industries. We believe the regulators are now trying to understand how to properly regulate the industry so that it can move towards a fairer and more competitive direction as a whole, including on pricing, data processing and product cross-sales etc. While the leaders may feel constrained by potential new rules, this may provide a more constructive environment for the rest of the industry.
EXHIBIT 1: MARKET PERFORMANCE OF CHINA EQUITY INDICES SINCE FEBRUARY 17, 2021
% CHANGE IN VALUE FROM FEBRUARY 17, 2021 TO MARCH 19, 2021
Source: Bloomberg Finance L.P., J.P. Morgan Asset Management.
Data reflect most recently available as of March 19, 2021.
On fin-tech, the regulator’s objective would be to mitigate systemic risks to the financial system. Hence, fin-tech companies might need to boost their capital base and operate more like a traditional financial institution.
Investment implications
We expect the market to remain volatile in the short term as it could take investors some time to re-price rising global rates, global economic recovery, domestic policy normalization and ongoing regulatory changes. However, this does not alter our constructive view on Chinese equities in the long run. Domestic monetary policy normalization should be seen in the context of improvements in the domestic economy, and subsequently earnings recovery. Hence, the introduction of any modest and gradual tightening implies a stronger economic backdrop while specific sectors (such as financials) could potentially benefit. Admittedly, regulatory uncertainty will likely cap the upside for related companies in technology, but these changes could open new opportunities for other players in the sector if anti-trust behavior is addressed.
China remains to be one of the more volatile markets in Asia and this highlights the importance of active management in stock and sector selection. Investors should stay focused on the overall macro and corporate fundamentals backdrop. In particular, investors still have affluent structural growth opportunities in a variety of long-term investment themes, including consumption, technology localization, carbon neutrality and renewables, and digital infrastructures. Sector leaders will continue to benefit from China’s economies of scale as well as additional supportive government policies. Long-term investors could start to buy high-quality stocks which have recently pulled back considerably. On top of long-term positioning in Chinese equities, investors should also look to diversify to other markets in Asia to fully capture the global recovery story.
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