Chinese stocks are like a small engine that no longer runs. After showing signs of economic recovery in the first five months of the year, stocks are losing steam again as investors expect authorities to take further steps to revive the economy, revive the property market and boost confidence at the next two policy meetings.
Investors are keeping their eyes on the upcoming Politburo meeting in July, although an exact date has yet to be set, and perhaps more importantly, the anticipated Third Plenum, a major gathering of the party’s Central Committee where major policy shifts and economic decisions have traditionally been made.
Any significant policy change would be welcomed as investors struggle to recover from the pandemic amid efforts to pop the real estate bubble and a crackdown on the private sector. Market optimism builds when Chinese authorities tell investors what they want to hear about policy reviews, only for the gains to evaporate if subsequent measures prove insufficient to stabilize the property market, restore consumer, business and household confidence, or ease tensions with the West.
“The Third Plenum will be critical in whether Beijing uses the opportunity to address key economic issues or fails to act,” said Andy Rothman, investment strategist at Matthews Asia, who expects the meeting to take place in mid-July.
The movement
iShares MSCI China
The rally in exchange-traded funds (ETFs) illustrates the hopes followed by disappointment among Chinese investors. The ETFs rose more than 15% this year through May, buoyed by extremely low valuations, Chinese authorities’ willingness to try something different to fix the property market and stabilizing returns in parts of the market.
But now, more than half of those gains have been wiped out, with the iShares MSCI China trading at $42.42 as of Wednesday morning, likely due to a lack of action from authorities, ongoing geopolitical concerns related to increasingly aggressive Chinese behavior around Taiwan, and trade restrictions from the United States.
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That disappointment and similar experiences over the past few years have investors keeping expectations low for the July meeting, with few expecting a major stimulus package or a major reversal of the economic trajectory outlined by Chinese leader Xi Jinping.
Investors have welcomed some recent developments, including new loans for struggling state-owned property developer Vanke Group to tide them over until demand recovers, as well as plans by authorities to buy up unsold stock and convert it into affordable housing to tackle a persistent property glut.
Though the plans so far have been small, addressing just 7% of excess inventory, Todd McCrone, emerging markets growth manager at William Blair, sees the efforts as another step in the right direction. “They’re taking tail risk out of the economy,” he says. “Valuations could go up a little bit because the risk of a total collapse of the real estate market is reduced.”
Still, he said more work needs to be done to move the stock price sustainably.
HSBC said this could involve policymakers cutting deposit rates to encourage households to reinvest some of their money into shares and property, and persuade investors that the days of erratic policymaking are over.
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“The government is keen to see a recovery,” strategist Gerard van der Linde wrote in a client note. Another valuable move would be a change in tone from officials that would signal they want to stabilize the property market, rather than continuing with comments about reducing debt and bursting price bubbles, he said.
More clarity on the direction of the economy and how policymakers will address a much-changed real estate sector would also be helpful.Paul Espinosa, who manages the Seafarer Overseas Value and Seafarer Growth & Income funds, wants to see China flesh out its corporate bankruptcy laws to spell out how it will deal with bad loans.
“That’s where the real estate issue really comes in,” he said. “From a domestic and foreign investor perspective, it’s about the laws and the risk factors.”
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Meanwhile, geopolitical clouds are only growing darker as China steps up its activities around Taiwan: U.S. Ambassador to China Nicholas Burns told The Wall Street Journal that Chinese authorities are undermining ties between the two countries by questioning and intimidating Chinese citizens who attend U.S.-sponsored events and stoking anti-American sentiment.
The potential for escalating tensions comes as both US political parties seek to take a tougher stance on China ahead of the election, with both parties floating a range of proposals aimed at limiting ties between the two economic giants.
A plethora of challenges, from geopolitics to uncertainty about China’s overall economic policies, have led fund managers to go bargain hunting and hold fewer stocks than they should. Some are leaning toward companies that are growing earnings well but want to return cash to shareholders, such as Tencent Holdings Ltd.
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HSBC’s Mr. van der Linde advises clients to avoid investing in companies that are at risk of being affected by geopolitical maneuvering or aggressive domestic policies, such as sectors that governments want to grow, like renewable energy and electric vehicles.Instead, he favors parts of the economy that are under-capitalized and difficult to export, such as sportswear, travel, factory automation and copper and aluminum.
The reason is that further consolidation is likely, giving investors a chance to profit even if authorities disappoint again on policy front.
Contact Reshma Kapadia at reshma.kapadia@barrons.com.
