Profitable business makes your profit
Since reaching its peak in February 2021, the market value of the MSCI China Index has evaporated by over $2 trillion, with the exchange-traded fund iShares MSC China (MCHI) falling by more than 50%.
Currently, the Chinese stock market is one of the cheapest in the world, with the MSCI China Index's price-to-earnings (P/E) ratio close to 12 times, compared to 15 times for the MSCI Emerging Markets Index and 20 times for the MSCI World Index.
Some fund managers believe that Chinese stocks are now very cheap and are ready to rebound, with the stock market bottoming out as policymakers introduce measures to stabilize the economy. However, some investors remain concerned about structural challenges affecting China's long-term growth prospects.
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Howie Schwab, fund manager at the Driehaus Emerging Markets Growth Fund, said: "The baseline has now been lowered, and the stock market will only go lower if the situation worsens further. If this does not happen, it may trigger involuntary short covering, somewhat similar to what happened in the middle of 2023 when investors panicked about rising interest rates and short covered speculative tech stocks in the U.S. market that were not yet profitable."
The rebound from short covering may be less than the market rebound when China relaxed its COVID-19 control measures at the end of 2022, but the Chinese stock market could still see a 10% increase, similar to the rebound seen in the Japanese stock market during the deflationary period.
Other analysts share similar views. Michael Hartnett, a strategist at Bank of America, called China "the most attractive contrarian long in the world." With the Chinese government introducing more measures to stimulate economic growth, nearly $12 billion of funds flowed into the world's second-largest economy in the past week.
In order to boost loan demand, the People's Bank of China recently announced a 0.50% reduction in the reserve requirement ratio, double the usual amount, while also asking domestic financial institutions to support cash-strapped real estate developers.
At the same time, some officials have made statements committing to support the stock market, and there are also reports that China may introduce a plan to guide the "national team" to buy A-shares. Ramiz Chelat, an emerging markets equity strategist at Vontobel, believes that all of this indicates that the government may have seen the need to take more action. Chelat has recently selectively increased his holdings in Chinese stocks, but the weight of Chinese stocks in his portfolio is still lower than his benchmark.
Chelat said: "This is a short-term bottom and support, and for a sustained rebound, more substantive consumer stimulus measures need to be introduced, or the issue of local government debt needs to be resolved."
Chelat pointed out that he would like to see a reduction in the phenomenon of downward profit forecasts in some Chinese industries. It may take some time for the profit prospects in strategic areas such as semiconductors and renewable energy, where the Chinese government has heavily invested, to improve, as these sectors currently face issues such as overcapacity and falling prices.Some hope to see more consistent policies from China in addressing structural issues such as debt and population, while taking action to revive confidence in the private sector. Therefore, in addition to supportive rhetoric, investors are looking for clearer policy signals, especially when the government has been restrained in introducing stimulus measures.
Gavekal real estate analyst Rosalea Yao recently pointed out that in the past few years, China's real estate sales have dropped from 18 trillion yuan to 12 trillion yuan, and the decline in real estate prices still exists, thus more measures are needed to stabilize the real estate industry.
Furthermore, although the government encourages local governments to convert unfinished or idle projects into affordable rental and for-sale housing, Yao noted that developers facing a lack of funds need support from external financing.
The stabilization of the real estate market, which accounts for a quarter of China's economic activity, is seen as a prerequisite for a sustained and comprehensive economic recovery.
Vivian Lin Thurston, portfolio manager of the William Blair Emerging Markets Growth Strategy Fund, said: "Currently, Chinese stocks are at an oversold level, and the first stage of the rebound may be driven by technical factors, but ultimately investors need to see further comprehensive economic recovery."
Thurston said that she has been paying more attention to Chinese stocks, but before taking action, she would like to see more signs of economic recovery, such as the stabilization of existing and new home sales after two years of decline.
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