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Written by: Gabriela Santos
2023 marked a third consecutive year of double-digit declines for Chinese equity markets, now down 60% from their early 2021 highs, led almost entirely by a multiple derating. Foreign investor outflows increased in the later part of 2023, with Chinese equities at decade low allocations in global portfolios. As the Year of the Dragon is about to begin in China, investors wonder: Are Chinese equity valuations cheap enough to bring good fortune ahead? What will turn investor sentiment around? Equity valuations already reflect a lot of uncertainty about the short-term and long-term path, suggesting a tactical rebound may be in the cards. Importantly, alpha opportunities exist in targeted exposure to new growth areas, such as business innovation, domestic consumption, and the energy transition.
The pendulum of investor sentiment swung wildly last year, from initial optimism about China’s reopening and potentially 6% GDP growth to pessimism about the economy finding its foot. To close the year, China’s economy did register a growth improvement to 5.2% from 3.0% in 2022. However, household consumption was weaker than expected and both private and real estate investment continued to contract. Chinese equities do seem to reflect quite a lot of pessimism about the path ahead. The MSCI China’s price-to-earnings (P/E) multiple is currently at 8.4x, having derated by over 50% since early 2021. As we highlight in the 1Q24 Guide to China, MSCI China’s P/E has only been lower than this four times over the last 20 years (2008, 2011, 2013 and 2022). These turned out to be followed by powerful tactical rebounds, by on average +60%.
What should investors look for to turn sentiment around? An improvement in consumer and business confidence, a bottom in real estate activity and prices, and an easing of deflationary pressures would give investors more conviction that 5% GDP growth is achievable this year and that earnings expectations can find a floor. Since October, Chinese policy makers have been providing targeted monetary, fiscal and quasi-fiscal stimulus aimed at the supply side of the economy. Monitoring the credit impulse can provide investors the most complete picture of the policy transmission. Over time, policy can help put a floor on growth and the market.
After three tough years for Chinese equities, valuations incorporate a lot of cyclical and structural uncertainty and suggest a tactical rebound ahead. Beyond a tactical beta rebound, investment opportunities do still exist to generate alpha by focusing on key priority areas in which earnings growth should exceed overall economic growth. These include areas within the “new new economy” sectors of business innovation (such as automation), green technology (such as companies involved in the electric vehicle supply chain), and consumption (such as domestic companies focused on rapidly changing consumption patterns). In addition, broader Asia and EM stories are increasingly less correlated to Chinese equity movements, providing a complement to China exposure. In particular, these include opportunities in Japan, India, North Asia, and Latin America, which combine positive short-term and long-term tailwinds.
In 20 years, Chinese equity valuations have only been lower in four episodes
MSCI China Index, forward P/E ratio, monthly
Source: Bloomberg L.P., MSCI, J.P. Morgan Asset Management.Price-to-earnings ratio based on next twelve months earnings estimates. Dividend yield based on next twelve months dividend estimates. Price-to-book based on trailing 12 months book value. “Std. dev” = Standard deviation. The recovery periods show returns for the MSCI China Total Return Index in USD. Guide to China. Data are as of January 31, 2024.
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