How 2022 is shaping up to be a year of redemption for Chinese equities

Chinese stocks are holding their own even as aggressive liquidity tightening and recession worries trigger sell-offs in the US and Europe
With much of the bad news priced in and efforts to stabilise China’s economy bearing fruit, investors who reduced their China exposure would be wise to revisit their position

Aidan Yao

Published: 1:30am, 30 Jun, 2022

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Fears of receding central bank liquidity and risks of a recession have curbed investors’ enthusiasm for holding risky assets, resulting in large drawdowns in global equity markets this year.

At the centre of the shifting liquidity paradigm, an increasingly hawkish US Federal Reserve has committed to an aggressive interest-rate-rise agenda to tame inflation, which currently stands at a 40-year high.

The Fed’s operation, which includes shrinking its balance sheet, is expected to significantly reduce liquidity in the real economy and financial markets in the coming years.

To make matters worse, the Fed is slamming on the brakes when the US economy is already showing signs of fatigue. Falling house sales, stalling retail spending and slowing job creation are just some recent signs of the economy struggling amid tighter financial conditions.

With the risks growing that the economy is reaching a tipping point, it is understandable why investors are hunkering down.

Similar behaviour can be seen in Europe, where the European Central Bank is increasingly expected to raise interest rates despite the risk of a recession. The Euro Stoxx 50 has fallen by about 20 per cent since its January high, entering a bear market. Meanwhile, the S&P 500 and Nasdaq have shed some 18 per cent and 27 per cent from their respective 2022 peaks.

Compared to the doom and gloom in developed markets, Chinese equities have fared well. The benchmark CSI 300 has gained 14 per cent since mid-April, while the Hang Seng Tech Index – China’s equivalent to the Nasdaq – has jumped 46 per cent from its year-to-date low. After massively underperforming, compared with other markets in 2021, Chinese equities appear to be making a comeback.

Pedestrians are reflected in a window of the Nasdaq MarketSite in New York, US, on June 15. The S&P 500 and Nasdaq have shed about 20 per cent and 25 per cent from their respective 2022 peaks. Photo: Bloomberg

So what is behind China’s trend-bucking move? For a start, market valuations are attractive. Forward earnings multiples of the MSCI China index collapsed from over 19 times in early 2021 to less than 9 times in March, but have risen gently, to 12.4 times now – still below its long-term average. This suggests that a lot of bad news has already been priced in.

On the macro front, while the current economic backdrop is challenging, policies have clearly turned a corner. Both monetary and fiscal easing have started to gain traction in an economy where some Covid-19 restrictions have been removed to allow activities to resume.

While growth headwinds remain, Beijing is set to intensify its efforts to stabilise the economy in a politically sensitive year. This bodes well for a corporate earnings recovery, which is needed to sustain the market rally.

Furthermore, the worst of the regulatory tightening appears to be over. Recent reports of authorities concluding data probe into big tech firms and restarting gaming approvals serve as the clearest signs to date that the crackdowns are easing.

People play online games at a booth at the 19th China Digital Entertainment Expo & Conference in Shanghai. China’s regulator granted publishing licences to 60 online games earlier this month, in the biggest mass approval of titles for computers and smartphones since July 2021. Photo: VCG/VCG via Getty Images

This followed reassuring words from senior policymakers to address market concerns, including working with the US Securities and Exchange Commission to ensure the continued listing of American Depositary Receipts (ADRs) of Chinese companies, and pledging that local regulations would be implemented in a transparent, predictable and market-friendly fashion.

Scepticism abounds, but incremental developments do seem to suggest Beijing is serious about repairing investors’ confidence and restoring a critical funding channel of the economy.

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Finally, liquidity is abundant to support a continued equity market rally. Contrary to the Fed and ECB, which are struggling to contain inflation, the People’s Bank of China is free of any inflation concerns and is firmly on an easing cycle to keep the economy well-oiled.

Traditionally, the real estate market had been the biggest beneficiary of monetary easing. But this time appears to be different, given Beijing’s desire not to use property as a tool to stimulate the economy. That makes the equity market a strong contender for the liquidity windfall, which could help cement the bull run.

For global investors, who have either neglected China or significantly cut back their exposure in recent years, now may be the time to rebuild their underweight positions. China’s economic and policy cycles, which differ from developed markets, offer investors a useful tactical hedge against inflation, recession and monetary policy tightening.

There are obvious risks in Chinese equities too, but investors seem to be getting a decent deal as valuations have fallen a long way over the past year. With sentiment improving and attention shifting to improved fundamentals, 2022 could be a year of redemption for China’s equity markets after the disastrous performance of 2021.

Aidan Yao is senior emerging Asia economist at AXA Investment Managers

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