The battered Chinese stock market
When China’s 2023 GDP growth rate was published in January, it met expectations of a 5.2 per cent growth. Under normal market conditions, the economic data should not have caused the big market gyrations. However, investors were thirsty for good news of some kind, which the data did not provide. The economic data showed plain development without signs of progress in private consumption and the real estate market is under stress.
Graphs 1 and 2 illustrate the challenging developments. The retail sales disappointed in December wherein the markets had expected an increase of 8 per cent against the 7.4 per cent. The combined 5.5 per cent yearly growth in January and February might look even lower, though slightly above expectations, but not fantastic. Also visible is the consistent price pressure in the housing market; not steep drops, but there is a slight pressure. For a market where the investors already had a negative bias, this just fuelled more selling.
The ongoing sell-off in the stock market in January triggered huge amounts of sell-orders linked to so-called “snowball” derivatives which were sold to private investors. These sell-orders are not the sole explanation for the diving market; fresh selling was the main reason.
In addition, the harsh Chinese official rhetoric after the Taiwanese presidential election scared investors once more, and even provoked new comments about China as being “uninvestable”.
During the first quarter of 2024, the Chinese stock markets have stabilised and, since mid-January, shares have advanced 4 to 5 per cent despite a continued drop in housing prices as Graph 2 shows. We take it as a certain stabilisation.
Causes of the downward trend
We, of course, also watch the real estate market with concern, though it’s predominately the real estate developers that will collapse. Concerning private house owners, we are less worried. They might see house prices slightly under pressure, but not enough to create a crisis for the households.
Taiwan is certainly a cause for the global headwind against China which also sent the stock market lower. In the big speeches, we do not recognise any change in the official Chinese wording about Taiwan. The Taiwanese presidential election was followed by harsh Chinese comments, and that was to be expected.
We have also done extensive research in understanding the Chinese military power. The very short conclusion is that China can invade Taiwan, however, China cannot match the US military force and will not be able to do so in the next five to six years. We are not forecasting a military conflict at that point in the future. On the contrary, we argue that too much fear about a Taiwanese conflict is priced in the share prices.
Overall, the Chinese stock market might look cheap, but we see big differences in the market. Fundamentally, we generally avoid having banks in the portfolio; more sectors are moving towards overcapacity especially the industrial/manufacturing sectors, but potentially also within chemicals and electronics goods. In our perspective, this is a clear indication that only a part of the Chinese stocks is attractive.
Interesting sectors are, for example, green and renewable energy, high-tech companies, a broad spectrum of digital companies, software, and many parts of the service sector.
Moves towards a positive outcome
As a response to the ongoing bearish stock markets, the government introduced different initiatives that they hoped would stabilise the market. The initiatives reach from lowering the stamp duty on stock trading, reducing the number of IPOs, and even making use of intervention.
This does not make us excited; instead, actions like an intervention should be avoided at any time. Instead, politicians should generate healthy conditions for the companies, then the stock markets will for sure perform well.
Government initiatives in China also include an easing up for listed companies to execute share buyback programmes. This is extremely encouraging as it can be a game-changer for the Chinese stock market. Share buybacks have been a strong force behind the positive American stock market during the past decade.
Concerning China, it is worth it for investors to observe that the new rules are very loose. This means that cheap shares that are bought back can be sold to staff or used at the executive level. From an investor perspective, this is bad, and only the companies that cancel the shares they have bought back are interesting in this context.
International investors have partially offloaded Chinese shares due to the global political headwind against China. We argue that many investors are not paying attention to the serious efforts that are made between the US and China to re-establish official relations at all levels.
A very good example was the meeting between the US government representative Jake Sulivan and the Chinese foreign minister Wang Yi in Thailand on the 26th and 27th of January. The meeting was not secret, though not in the press limelight either. This was not the first of these meetings; this latest meeting most likely will lead to a new telephone conversation between US President Joe Biden and China’s President Xi.
We would regard this potential shift in the relationship between the US and China as a very positive step, and certainly not priced in by the international investors yet. When we combine all these factors, we consider the interesting part of the Chinese stock market as 35 per cent undervalued compared to the global stock markets – the art is to find the undervalued part of the Chinese stock market.
