July 11, 2024
Since the lunar new year, China’s equity markets have showed signs of a comeback, suggesting a recovery of confidence in the broad economy as well as the equity market, albeit slow, may be gathering momentum. Although some challenges persist – such as the travails of the property sector and geopolitical issues – policymakers have rolled out more concerted measures to ensure the sustained recovery. We spoke to Christine Pu and Nathan Lin, co-heads of China equity for Goldman Sachs Asset Management, for their thoughts on China’s economy and stock markets.
China registered better-than-expected GDP growth figures in the first quarter of 2024. What’s your take on that data?
GDP growth has undoubtedly fared better than expected for China in the first quarter. China met its 5% GDP target last year, and clocked 5.3% year-on-year growth in the first quarter this year. Some areas that have been promising include fixed asset investment – driven by faster manufacturing and infrastructure investment – industrial production, and services. On the consumption side, the service sector recovery has been strong, and tourism spending edged over 2019 levels.
But we also need to acknowledge the fragility of the recovery. Since April, we witnessed some slowdown in retail sales, industrial production (driven by the computer and electronics industries). Meanwhile, property markets have remained in negative territory despite easing measures nationwide, with the decline in price and liquidity situation of property companies being key concerns.
We therefore expect certain government policies to remain in place, such as the policies on large-scale equipment renewals and consumer goods trade-in to stimulate demand, the issuance of the 1 trillion RMB ultra-long-term central government special bonds, and the acceleration in local government special-purpose bond (LGSB) issuance, as well as more recent policies for easing in the property sector.
Within this context, how do you view stock earnings and valuations?
We believe earnings and valuations remain attractive and, in our view, have potentially priced in the current backdrop, whilst allocation from foreign investors has stayed historically low. One-year forward multiples for the CSI300 and MSCI China indices stand at 11.6x and 9.6x, well below their historical averages. Earnings are on path to recovery for the CSI300 (Goldman Sachs’ top-down estimate being 9% / 11%) and MSCI China Index (8% / 10%) for 2024 and 2025 respectively, in local currency terms. While some normalization for earnings estimates may be in order, the rebound in earnings for industrials, utilities, and IT do paint a supportive longer-term trajectory.
How do the government’s capital market reforms play into this story?
We notice government policies aim to strike a balance between professional market development and investor protection. China’s State Council in April issued the “Nine-point” guidelines (or “Nine Measures”) for to develop capital markets. The “Nine Measures” are guidelines that the government lays out every decade. In its most recent iteration, the policy narrative has shifted from “healthy development” to “supervision to prevent risks” and “high quality development.” This calibration seems largely in-line with China’s broader economic focus. The measures include a call to improve IPO listing rules; strengthening information disclosure; deepening reforms on delisting and disposal; and promoting five key areas (tech, green investments, inclusivity, pensions, and digital infrastructure) amongst others. Notably, dividend payments and buybacks have reached an all-time high in the recent results season, having increased roughly by a factor of nine since 2008.
When it comes to your own portfolios, where do you see opportunities?
We continue to adopt a bottom-up approach in identifying quality companies. We see potential opportunities in China’s equity markets in four key categories:
- Advanced manufacturing: China increasingly dominates the global industrial robot market and EV production, with a market share greater than 50%. We continue to see rich potential opportunities in this space given the government push for technology upgrades and modernization of the industrial system.
- Technology innovation: In real terms, China’s spending on research and development (R&D) has grown to $669 billion in 2021, according to the most recent data from the OECD, rapidly narrowing its gap with US. We expect to see the rise of more companies leading innovation in IT and healthcare.
- Resilient consumption: Funding for urbanization and consumer durable trade-ins has the potential to improve domestic aggregate demand. We like leading home appliance companies and cross-border e-commerce players that leverage China’s competitive supply chains.
- High-yield dividend players: We believe this remains an attractive and arguably more defensive opportunity. Given macroeconomic uncertainties, we think companies with more stable free cash flows and good shareholder returns look attractive.
What are the top risks that clients should be concerned about regarding China?
We would divide the risks into two buckets: internal and geopolitical. On the former, navigating the property downturn, solving unemployment in the 16–24-year age category, and facing the challenges of deleveraging and a shrinking population remain top of mind.
Geopolitically, tensions with the US, when considering the potential outcome of the US elections in November, as well as regional tensions with neighbors, will both have consequences. A world of increasing protectionism – for instance, renewable- and EV-related sanctions in Europe, or trade sanctions with the US – will no doubt need to be assessed by policymakers as well as investors looking to gain exposure.
Despite the risks, we adopt a positive view on Chinese equities. A combination of a broad-based policy response, continuous technological innovation, and resilient supply chains, as well as a focus on capital market reforms, bodes well as fundamentals improve. Alongside that, a combination of bottoming-out earnings and historically low valuations makes an attractive entry point, especially as investors have low expectations and extremely low allocation to the market.
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