Active Thinking

At GAM Investments’ latest Active Thinking forum, Wendy Chen discussed the impact of the Chinese Vice Premier’s speech addressing key market concerns and her view on China’s recovery.

13 April 2022

Last year, with the wave of regulations, China lost its equity premium over the emerging market for the first time since 2007. With concerns over China’s involvement in the Russia-Ukraine conflict, mid-March saw China’s index hit an all-time low. However, this fall was followed by the highest volume traded and the biggest one-day rebound ever seen for Chinese shares, fuelled by the speech of China’s Vice Premier Liu He, in which he addressed key market concerns.

We believe the solutions proposed by Liu He and the Chinese government can be implemented with varying degrees of difficulty. The most actionable of these is monetary policy. China is one of the largest economies in the world that still has some gunpowder in terms of expansionary monetary and fiscal policy to support growth. Up until now, China has held back on injecting liquidity into the market so that is an immediate actionable point to back the 5.5% growth target, in our view.

Additionally, the US and China are working on a concrete coordination plan for American Depository Receipt (ADR) auditing. Although this will require international cooperation, in our view, the tone of China regulators giving access to audit most firms is promising.

Slightly harder to execute on is the widespread real-estate market crisis. Risk management mechanisms and supportive measures are needed to smooth the transition to a new development model. We believe deleveraging will be a gradual process and take a long time, as regulators are already halting some drastic measures, like property tax, to avoid a hard landing.

Finally, we believe the hardest issue to address relates to Covid policy. We are not seeing any changes this quarter and there is an emphasis on ensuring there are no new Covid surges. This is evidenced by doubling down on the lockdown period in Shanghai despite obvious economic impact and rising public opinion. We believe a balance needs to be struck between Covid containment and economic growth as the variants evolve rapidly.

With the Omicron variant in China picking up significantly since March, it is severely affecting almost all provinces. First quarter results are still deteriorating, with April potentially marking the near-term bottom: March to April is usually the peak season for house sales in China; however, preliminary March sales for the top 100 developers have further deteriorated to -52.7% year-on-year. Additionally, with the locked-down Jilin and Shanghai provinces, accounting for more than 20% of Chinese automotive manufacturing, supply chains are under a lot of pressure, notably with the closure of the Tesla factory in Shanghai. This also reflects consumption sentiment, with consumers worrying about jobs and salary cuts. Finally, intentions to travel in 2022 are even lower year-on-year, following levelling-up local mobility restrictions and flight safety concerns.

Currently we are seeing stocks fluctuating due to a combination of positive and negative stimuli. The positive US audit access to most ADR firms and the delayed property tax proliferation is counterbalanced by the zero-Covid policy, further constraining economic growth and disrupting supply chains.

If we compare the current environment with 2020, which was a very good year for Chinese equities across all aspects, we can use 2020 as a benchmark for what we need to see to start reinvesting in China. Since the second half of 2021, negative shocks on regulation, geopolitics and US-China relations have drawn notable liquidity out of Chinese equities, driving valuation to favourable territory. The impact on macroeconomy and company earnings means they will likely still lag in the first half of 2022. Towards the end of the first quarter of 2022, we are seeing potential bottoming of regulatory shocks and toned-down geopolitics (with China displaying a neutral stance in the Russia-Ukraine conflict) following Liu He’s speech. We are hoping to see macroeconomic conditions and company earnings follow in the second half to create a more neutral stance across the board. US-China relations are still difficult to predict, with much dependence on the SEC and whether they will delist Chinese stocks anyway. We believe a bottoming in first quarter company earnings should encourage both central banks and regulators to be more aggressive, hopefully leading to a successful recovery.