China’s stock market: company earnings will plough ahead in the Year of the Ox

While investors have piled into the A-share market, there is still value to be found. Apart from consumer stocks likely to benefit from China’s growth and those boosted by changing habits as a result of Covid-19, companies related to green energy could also do well

Nicholas Yeo

Published: 10:15am, 12 Feb 2021

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China’s economic rebound from the coronavirus shock allied to enduring structural growth promises to propel local company earnings in the Year of the Ox – in keeping with the creature’s fabled characteristics.

Oxen are esteemed in Chinese culture for strength and hard work. The ox-like endurance of China’s economy will enable productive firms to plough ahead, to the benefit of investors.

The MSCI China A Onshore Index surged more than 40 per cent last year. This rally reflects the resilience of domestic company earnings after China acted quickly to reopen its economy from lockdowns. Further, it highlights the positive outlook for earnings in the year ahead.

China recorded 2.3 per cent year-on-year gross domestic product growth last year – one of only two G20 nations in line to record positive growth for 2020. Chinese authorities were able to bring Covid-19 infection rates down sharply, while its policymakers stimulated the economy. This earlier restart relative to other economies gives investors greater clarity on the outlook for earnings.

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This inherent economic strength is driving investors to be long on China’s A-share market, prompting fears of a bubble similar to 2015. Local retail participation is elevated, as is global investment into A shares via the Stock Connect trading scheme.

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Nonetheless, investors can still find relative value in A shares. With a forward price-to-earnings ratio of 17 times (based on 2021 earnings forecast), the MSCI China A Onshore Index is trading above its historical average. However, it remains at a 40 per cent discount to the S&P 500 on a price-to-book basis and is 23 per cent cheaper on a price-to-earnings basis.

These valuation levels appear well supported, too, with consensus earnings growth forecasts for 2021 comfortably in double digits for companies in the MSCI China A Onshore Index.

An investor looks at a stock quotation board at a brokerage office in Beijing on January 3, 2020. Photo: Reuters

Growth momentum is likely to slow this year as a natural consequence of China having recovered so rapidly – official GDP data shows China already back on its pre-Covid-19 trend.

But while investors can expect a reduction in fiscal support, it doesn’t mean China will suffer a major slowdown – only that financial conditions will move from accommodative to neutral. Our research institute forecasts that China’s GDP will grow in the high single digits for 2021.

Encouragingly, the authorities have pledged not to tighten policy rates too quickly – pointing to stability. If firms can continue to borrow at low rates, it bodes well for company earnings.

Moreover, policymakers retain dry powder to pull on monetary and fiscal levers and inject liquidity into the system to safeguard China’s recovery. It is because China is growing that policymakers are able to employ orthodox policies – which reduces the risks of fiscal slippage.

People walk past the People’s Bank of China in Beijing on January 15. China’s central bank is unlikely to tighten monetary policy in a hurry. Photo: EPA-EFE

However, there are still sectoral divergences for investors to watch out for. Looking ahead, consumption will become the key indicator of the health of China’s economy.

Investors might target quality consumer discretionary and consumer staple stocks in line to benefit from China’s structural growth. Covid-19 has changed some spending habits for good as people shop from home, supporting areas such as online delivery and digital health care.

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Another area where investors can anticipate growth is green energy, with China committed to achieving carbon neutrality by 2060. This transition will require mammoth investment into firms that provide renewable energy, batteries, electric vehicles and related infrastructure.

Already, Chinese firms are global leaders in the renewables supply chain. China’s wind turbine-makers account for 26 per cent of global capacity and its battery-makers 78 per cent. Moreover, China is responsible for 91 per cent of silicon wafer production to harness solar energy. Investors should focus on equipment-makers and companies operating within the value chain.

Chinese provinces and cities will be at the forefront of purchase orders for equipment to source wind and solar energy, and the batteries to power it. We have seen some forms of renewable energy reaching grid parity, where cost of production is the same as for fossil fuels.

There are also opportunities to invest in the electrification of transport – specifically in makers of batteries that power road vehicles – and in firms positioned to help China upgrade its national electricity grid to deal with anticipated growth in wind and solar energy.

Overall, investors need to think carefully about where to commit capital and what to avoid in the year ahead. But thanks to the ox-like resilience of China’s economy, they won’t be short of compelling growth options.

Nicholas Yeo is head of equities, China, at Aberdeen Standard Investments