Darkening gloom in Chinese stocks puzzles Wall Street veterans

HONG KONG – Confidence is in short supply among Chinese investors these days, confounding analysts who say reasons to own the market are finally coming true.

The MSCI China Index’s valuations are shrinking and 12-month rolling returns are negative, a sign investors are pricing in an earnings contraction. Recession-proof trades are gaining traction, with a defensive strategy of buying dividend payers suddenly among the year’s most profitable. 

Investor pessimism – worsened by US tensions – has become so entrenched it is suppressing prices when improving fundamentals may justify a move higher. The MSCI China is lagging almost every other global benchmark in April, even after economic data surpassed estimates by the most since 2006 and global banks raised their forecasts for earnings growth. 

“There’s a clear negative bias right now,” Ms Winnie Wu, China equity strategist at Bank of America Corp, said by phone. “There’s a sense that China’s post-Covid-19 recovery needs a longer track record. The problem is, a lot of people have no patience to commit now and wait.” 

Analysts are calling for an average 22 per cent surge in operating income for MSCI China companies – the fastest growth since 2011.

But investors keep selling: Tech shares are in a bear market and charts are forming ominous indicators. Mainland and Hong Kong stocks lost a combined US$866 billion (S$1.16 trillion) in just over a week – a faster sell-off than during October’s capitulation.

Fears of what China would look like under President Xi Jinping’s total control led to

a massive sell-off

following

the party congress in October.

While investors returned after Beijing dropped Covid-19 controls and promised to prioritise growth, the sell-off now may reflect the continued unease over a government that cracked down on the nation’s most profitable companies at the expense of the economy and investors.  

Market watchers see several reasons for the deteriorating sentiment. Most say tensions with the United States are spooking international funds, while some blame divestments by famed long-time China investors or corporate insiders. Others attribute it to scepticism about the recovery in consumption.  

Mr Mixo Das, Asia equity strategist at JP Morgan Chase & Co, says investors will soon run out of reasons to avoid holding Chinese stocks, with low multiples and better earnings driving prices higher.

The MSCI China is trading at just 7.6 times expected operating profit – 9 per cent cheaper than averages going back nearly two decades. The multiple is 34 per cent lower versus the MSCI All-Country World index and 45 per cent below the S&P 500’s valuation.   

Such discounts are typical during periods of acute stress, like the 2020 Wuhan lockdown, the 2018 trade war, the hard-landing era of 2016 and the bursting of the stock bubble in 2015. But unlike those times, it is difficult to find anyone bearish enough to predict a crash in China’s economy or financial system right now.  

Morgan Stanley’s Asia-based strategy team, known for advising against buying the dip throughout the stock sell-off in 2021 and 2022, have just reiterated their bullish call on China because they expect better growth and relations with key economic allies to improve.

For Abrdn, the pullback is a “good opportunity for long-term investors” to get into reopening-related stocks, according to Ms Pruksa Iamthongthong, senior investment director of Asian equities. 

That is not to say everyone is upbeat – far from it. Ms Pilar Gomez-Bravo, co-chief investment officer of global fixed income at MFS Investment in London, says it is still unclear whether the jump in March activity was distorted by the sudden reopening or a reflection of actual demand.  

“The People’s Bank of China is saying: Don’t worry, we’re sort of going through this path of reopening and kind of trust that we’ll kind of control that,” said Ms Gomez-Bravo, whose team is underweight Chinese government bonds and trimming its exposure in property high yield credit. “But unless you have a clearer picture, it’s too early to have conviction.” 

Much of the driving force for global flows into Chinese stocks is coming from geopolitics. Headlines concerning China’s stance on European countries and the war in Ukraine, military drills near Taiwan or the Biden administration’s restrictions on key technologies are adding to the market’s nervousness. 

“It scares a lot of institutional investors that would normally be willing to put a lot of money into China,” said Mr Mark Mobius, co-founder of Mobius Capital Partners. “It’s a real problem.” 

Another key risk is – what if the market’s gloomy outlook on the economy proves accurate in a few months? Asia funds, who unlike their US counterparts turned overweight on China during the reopening trade, are now cutting their exposure. Selling by global long-only investors has sapped China’s markets of liquidity because onshore investors have yet to plug the gap, according to Ms Wu at Bank of America Corp. 

“People are reluctant to be positive – this is a little bit natural after a long downcycle,” said Mr Das at JP Morgan. “The evidence is already there. The remaining bit is time.” BLOOMBERG