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Weekly Market Analysis: China's Reopening Rally, Part 2

Wealth Insights | Economy/Politics | Equities

Weekly Market Analysis: China's Reopening Rally, Part 2


3 Things to Know

China may have passed infection peak

After China’s reversal of its Covid-zero policy on Dec. 7, 2022, infection cases have surged. Hospitals are still overwhelmed, running far above capacity. However, the number of new patients visiting hospitals has stabilized, and in Guangzhou, the number has been declining since Dec. 23. Continued rapid spread of the virus since the time of the survey would suggest China may have already reached herd immunity.


 

Summary

China’s unexpected Covid policy reversal and its economic reopening have surprised many global investors. Health experts believe China has already reached herd immunity across the country and policymakers have comprehensively refocused efforts on restoring economic activity and bolstering market sentiment. These factors have produced a sharp equity rally off the bottom. Some observers wonder if the bull market is already over. CIO believes substantial appreciation potential remains for Chinese shares as revenue growth and earnings are likely to exceed modest expectations. The policy backdrop also remains supportive, with money and credit growth still robust. Further fiscal stimulus is likely as well. The mix of policy and economic direction is a powerful combination fueling equity returns.

Lifting 2023 growth expectations

China’s GDP growth in 2023 is likely to materially exceed CIO’s original GDP growth forecast of 4.5%. There are five key drivers of this growth, including faster than expected reopening from Covid-zero, fiscal and monetary easing for the property market, elevated money supply growth, the government’s focus on economic development, and easier comparisons to a weaker Q4 2022.


 

Portfolio considerations

In the near term, China’s economy is likely to rebound sharply while the rest of the world is still likely to slow down. This divergence is likely to sustain Chinese equity outperformance. CIO expects 15% earnings growth and a rerating of stocks back to a 13x PE this year. These conservative assumptions suggest a further 20-30% gain in share prices is possible in 2023.

 

Lingering concerns over geopolitics

The strategic competition between US and China would likely continue for many years to come. However, recently, China has taken steps to tone down confrontation, including replacing the combative foreign ministry spokesperson and naming a milder official as the ambassador to the US.

Unlike the March-April surge in cases, the current surge is not expected to bring lockdowns and market reaction is entirely different

Source: Bloomberg as of Jan. 10, 2023. Indices are unmanaged. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Past performance is no guarantee of future results. Real Results will vary.

 

China may have passed infection peak

After China’s reversal of its Covid-zero policy on Dec. 7, 2022, infection cases have surged. Although daily infection data is no longer published, the National Health Commission estimated that close to 300 million people were infected by end-December. Hospitals are still overwhelmed, running far above capacity. However, the number of new patients visiting hospitals has stabilized, and in Guangzhou, the number has been declining since Dec. 23. Meanwhile, survey data published by various provincial health authorities suggested some large provinces such as Sichuan, Henan and Guangdong have seen their infection rates reach 70-80%, as of Dec. 26. Megacities with large populations, such as Shanghai (23mn) and Beijing (22mn), also reported over 60% and 80% infection rates, respectively. Continued rapid spread of the virus since the time of the survey would suggest China may have already reached herd immunity. According to Hong Kong University’s experts, high stress in medical resources is likely to persist for months, but if a country can weather through that peak, future waves are tolerable.

 

Reasons for lifting 2023 growth expectations

There are many signs of a rapid “return to normal” among China’s population, including mobility data, which has been improving sharply in January, and a rise in travel bookings of mainland China tourists before the Lunar New Year to Southeast Asian countries. China’s GDP growth in 2023 is likely to materially exceed CIO’s original GDP growth forecast of 4.5%. There are five key drivers of this growth: Faster than expected reopening from Covid-zero is helping to boost a consumption recovery in 2023 that may match or exceed that seen in 2021. Chinese households have accumulated CNY 15 trillion worth of new deposits in 2022, or a record 14% of GDP.  Second, the central bank and banking regulator have reopened credit and equity channels for property developer financing, which could potentially help the beleaguered property sector. Money supply growth in China remains elevated in contrast to the US. The government vowed to unwaveringly support both state-owned and private-owned enterprises, with fiscal, monetary, industrial, technology, innovation and social policies to engineer an economic recovery post-pandemic. Lastly, economic data has not improved for Q4 2022; it’s likely real GDP shrunk sequentially in Q4, taking the full-year GDP growth to 2.5-3.0%, below CIO’s earlier expectation of 3.5%. But now CIO sees the opposite effect likely in Q1 2023 and beyond, with factories reopening and people returning to their job sites.

 

Addressing lingering concerns over geopolitics and regulations

On the geopolitical front, the strategic competition between US and China would likely continue for many years to come. However, recently, China has taken a few steps to tone down confrontation, including replacing the combative foreign ministry spokesperson and naming a milder official as the ambassador to the US. Even though CIO doesn’t expect major improvement in the relationship, serious escalations may be avoidable in a year without major elections on either side. CIO suspects that geopolitical risks are unlikely to become an immediate hurdle to economic recovery in 2023. On the regulation side, several corporate developments may be notable. Various parts of government had taken small but “golden” shares in major internet platform companies. This may be seen as a sign of rising state influence, but it could also be seen as a prerequisite for maintaining access to capital markets.

 

Portfolio considerations

After a sharp 50% rally in the MSCI China index since last November, some observers wonder if the bull market is already over. But this rally had only recovered one-quarter of the 20-month bear market. CIO believes Chinese equities will eventually recover most of the bear market losses because there are sustained drivers for revenue growth and earnings upgrades. CIO expects the MSCI China index EPS to recover by 15% and for the PE ratio to return to 13x in 2023. These assumptions would bring EPS back to 2019 levels. In other words, these assumptions are relatively conservative. If borne out, this would imply 20-30% returns in 2023. Even if this occurs, the MSCI China would have recovered about 60% of the 2021-22 bear market decline.

 

Note: Past performance is no guarantee of future results. Real results may vary.