China stock rout not just about tech crackdown as earnings model shows 70 per cent odds of sharp contraction

Earnings model shows 70 per cent chance of a significant contraction in the coming 12 months: BCA Research

Stocks may see a tactical bounce in the next two to three months on policy stimulus bets, but a legitimate improvement in fundamentals is needed for an upgrade call

Reading Time:3 minutes

Stocks may get tactical bounce but it’s not yet time for a cyclical upgrade, BCA Research says. Photo: Xinhua

Published: 8:30am, 7 Jan 2022Updated: 3:34pm, 7 Jan 2022

More than US$97 billion of value in offshore Chinese tech stocks has been erased in the opening three days of 2022 in Hong Kong’s market worst start to a year since 2005. Investors banking on a swift turnaround should heed at least two warning signs.

While regulatory and geopolitical risks continue to haunt, the market also faces another negative factor in the form of earnings setback as growth in the world’s second-largest economy decelerates, according to BCA Research.

The odds of a significant earnings contraction over the coming 12 months are as high as 70 per cent, according to a model run by the Montreal-based research firm. The model has successfully warned of the three major contractions over the past decade, it said.

“In previous cycles, stocks only bottomed when the earnings adjustment process was well under way,” China investment strategist Sima Jing wrote in a report to clients on January 6. “This adjustment process has barely begun in the current cycle, which argues against a cyclically overweight stance towards Chinese stocks.”

The Chinese economy offered mixed recovery signals, deterring any move to upgrade its market recommendations, BCA Research said. While the official PMI and high-frequency, market-based growth indicator improved slightly in December, the underlying sub-indices were weak. New orders and business activity in the construction sector fell sharply due to sluggish infrastructure and housing drag, it added.

China International Capital Corp, the nation’s biggest investment bank, trimmed its gross domestic product growth forecast for 2022 to 4.1 per cent from 4.5 per cent, according to its report on January 4.