Weekly Brief: Overweight Chinese Equities?

Structurally we like Chinese equities, but tactically, for the most part, we've been underweight. How does the underperformance but regulatory uncertainty play-out for relative returns from here?

Some of the major financial institutions moved underweight China last summer. The economy was the first to recover from Covid lockdowns, earnings had rebounded and been helped in relative terms by relatively favorable offline to online trends which we thought would dissipate in 2021, valuations had become relatively very expensive, and we expected very easy monetary policy to be removed.

16 months on, policy has already tightened and the effects of this have been working through both the economy, valuations, and the broader market. Additional restrictions relating to the property sector have created risks, but we think they are manageable and the current situation is more than discounted. The worst of the credit impulse is likely behind us and policy looks more neutral from here.

Overexuberance toward China last summer has once again given way to disappointment. This is even more evident within the market, where more than 60% of stocks now trade below their own 5-year average multiples, at a time when the overall index trades above its long-term average multiple.

Last year's positive sentiment was most notable toward the internet sector, which has arguably compounded both the underperformance as regulatory fears have kicked in but also now what have become increasing calls that the sector is 'uninvestable' because of government intervention. Like the market, we didn't see the internet regulation coming. But when we compare the standard narrative toward the sector and regulation/common prosperity against the evidence that fines and actions are in line with broad global standards, there is a wide gap and we think investors are now too bearish on regulation.

“After global investment firms UBS and Nomura, Europe's biggest bank HSBC too has turned bullish on China's stock market. The bank argues that the worst is over in China. It says that the beaten down real estate sector is particularly attractive over the long term.”

Although relative valuations are lower and more attractive than six months ago, the uncertainty on policy, volatility, and tapering concerns keep many investors underweight for now, though we are closely watching the regulatory environment and policy reaction. We are much less negative than we have been because the worst seems to be over.

---

References:

PHOTO - Business Insider

Westbrook, N.. (2021, October 26). HSBC joins investors reckoning worst is over in China.

Thomson Reuters. HSBC joins investors reckoning worst is over in China | Reuters