Posted inChina

China weakness paves way for selective upside

A bottoming out of the domestic equity market is stirring some optimism in the internet and consumer sectors.

Signs of optimism are emerging for certain sectors in China’s equity market amid a recent bottoming out in macro data and a flurry of policy support.

Relaxations in the property sector, a reduction in stamp duty for equity trading and cuts to personal income tax that were greater than investor expectations are among key drivers for a potential turnaround in sentiment, according to UBS.

“We see several signs which historically would have suggested that the equity market may have bottomed out,” said James Wang, head of China strategy for UBS Investment Bank Research. He also pointed to some easing in geopolitical tension, with increased frequency of communication between government officials.

Other market commentators also see promising signals from recent economic figures. According to David Chao, global market strategist for Asia Pacific ex-Japan at Invesco, the latest data from China surprised on the upside and shows the economy could be on surer footing.

“Many indicators show that growth has stabilised after a disappointing second quarter and that the economy is set to improve over the coming month as stimulus measures take hold,” he added.

While Wang added that share prices remain soft, with major Chinese equity indices now below the level just before the July Politburo meeting, this scenario is to be expected.

“In our view, this divergence between fundamentals and share price performances may be the result of weak sentiment, which takes time to turn,” he explained.

In general, Chao is gaining confidence again in what he calls the Chinese economy’s main propellers – manufacturing, investment and consumption. “[They] are starting to throw off a bit of the previous month’s malaise. I suspect that the worst may already be over and even without a stimulus bazooka, a recovery, albeit an uneven and shallow one, is already well on its way.”

Looking past the headlines

The historical evidence that the equity market may have bottomed out includes significant monthly foreign outflows from A-shares, low trading turnover in A-shares, high levels of short selling turnover in H-shares and both the RMB exchange rate and 10-year government bond yields being at extreme levels.

In addition, economic fundamentals such as manufacturing PMI and credit impulse have shown improving trends.

UBS’ Wang also highlights the possibility that much of the below-expectation earnings for the second quarter can be explained by write-offs in the property sector and weak upstream earnings as commodity prices fell.

“Excluding the property sector, downstream earnings grew 15% YoY as gross margin recovered with consumer companies’ earnings up 14% YoY and autos, healthcare and defensives, [including] utilities and telecom, also seeing robust trends,” he said.

In particular, Chao at Invesco believes the bright spot is the pick-up in consumption, which could suggest that household sentiment has started to turn.     

At the same time, internet companies, which make up roughly 40% of the index, grew over 70% from lower costs.

“Our analyses on historical episodes during market troughs suggest that the subsequent best performing sectors included internet (e-commerce) and various consumer sub-sectors such as restaurants, leisure and beer,” added Wang.

As a result, the bank’s portfolio construction is geared towards those sectors, plus it has included expressways for defensiveness.

By contrast, on Wang’s least-preferred list are airlines, banks, materials and autos.

Electric optimism

The only caveat on the final sector is in the electric vehicle (EV) space, where Morningstar, for example, is positive. The firm sees selected buying opportunities on an improving sales and profitability outlook.

China sold 5.1 million units of passenger new energy vehicles (NEVs) in the first eight months of this year, with NEV penetration, as a percentage of total vehicle sales, reaching 32%.

“We think the market is still underappreciating the improving outlook for sales growth and profitability for the China NEV manufacturers,” said Morningstar equity analyst Vincent Sun. “After factoring in the potential recovery of delivery growth and profit margins for the second half of 2023, we believe shares of selected automakers under our coverage remain undervalued even after the rebound off second-quarter lows. Forward price/sales ratios remain undemanding.”

Part of the Mark Allen Group.