The Chinese economy and equities: prospects for the remainder of the year
China’s recovery remains uneven, with a dynamic external sector far outpacing a more sluggish recovery in domestic demand, while the recent spread of the Delta variant has led to the imposition of restrictions, which will take a bigger toll on the economy than previous episodes, especially on services.
In the presence of growing headwinds, the policy environment should turn more supportive in the second half of 2021. Monetary policy normalisation is likely over, and we expect an acceleration in fiscal spending. Recent regulatory action should be read through the prism of China’s shift from the pure pursuit of economic growth to a wish to foster “common prosperity”. Given the strategic nature of this shift, the current regulatory push is expected to last.
China’s swift regulatory actions have undoubtedly spooked financial markets even as tensions rise with the United States on US-listed Chinese firms. We expect the pressure on Chinese stocks’ valuations to continue in the coming months as Chinese authorities have not yet signalled an end to their regulatory campaign.
Prospects for Chinese earnings remain unexciting due to the slowing credit impulse in China, companies’ efforts to comply with new regulations and the potentially negative impact of containment measures linked to the spread of the Delta variant. As we struggle to see major upside for Chinese equities through to the end of this year, we are cutting our target for the MSCI China to HKD 100 (from a previous forecast of HKD 120).
Nonetheless, despite investors’ cautiousness towards overseas-listed Chinese stocks, there is still appetite for mainland-listed firms, which are less exposed to current regulatory action. Analysis of StockConnect trades indicates that while mainland investors have been net sellers of Hong Kong-listed shares (many of which are large technology stocks targeted by the current regulatory drive), foreigners continue to buy into domestic Chinese exchanges, which have remained steady. Overseas investors’ continued appetite for Chinese stocks is corroborated by positive flows into Chinese equity funds.
While we advise caution in the short term for sectors that may be in the crosshairs of the authorities due to the refocus on “common prosperity” or for regulatory reasons, the current crackdown does help understand how capital might be deployed in China to stay on the right side of regulators and match the Chinese leadership’s strategic priorities. High-end manufacturing (e.g. semiconductors), technology (AI, quantum computing), green tech and health care (biotech) should all benefit from China’s latest five-year plan—but beware high valuations.