Chinese equities a buying opportunity now

By: iFAST Research Team / Pic by BLOOMBERG

Headwinds facing China’s economy in 2022 included regulatory crackdowns, a crisis in the property market, renewed outbreaks of COVID-19 and the potential for Western sanctions given its relationship with Russia.

While we have been positive on Chinese equities, our convictions have so far not worked out as expected, with the MSCI China Index down by 15.4% year-to-date to become the worst performing stock market under our coverage.

Few Chinese companies have caught the attention of global investors like its tech firms.

For more than a year, President Xi Jinping unleashed a punishing regulatory crackdown on the country’s biggest tech companies, causing a catastrophic sell-off in the sector.

At one point in March, the Hang Seng Tech Index – which tracks the 30 largest tech companies listed in Hong Kong and serves as a proxy for China’s tech sector – had lost about 70% of its value since its 2021 peak.

Yet, despite the obvious risks, we think the deep sell-off in Chinese stocks could finally be on the cusp of a turnaround, as the government rolls out more policy support measures,

Covid lockdowns have begun to ease and signs of easing in the year-long crackdown on China’s tech sector. As such, we have upgraded Chinese equities.

Earnings outlook has been overly pessimistic

We believe investors may have been too pessimistic on the earnings outlook for Chinese companies, following a string of better-than-expected earnings results. Alibaba reported better-than-expected earnings and sales for its most recent quarter, while Baidu also posted stronger-than-expected earnings.

Even though Baidu’s adjusted earnings per share in the first quarter (1Q) was down by 9.3% year-on-year, it still managed to beat earnings expectations by a wide margin – a sign that earnings estimates have been overly pessimistic.

This is in stark contrast to the US equity market, where earnings estimates for the S&P 500 Index have barely budged this year, but has already seen a number of high-profile earnings misses, especially from the likes of Walmart and Target. Target, in particular, has recently cut its profit outlook for the second time in almost three weeks. Amazon’s first quarter earnings were also a big disappointment, while Snap issued a profit warning and said it planned to slow hiring and spending. For comparison, earnings estimates for the MSCI China Index have already been slashed by 12.0% this year.

Besides, there are several catalysts on the horizon that could jumpstart a turnaround in Chinese equities, including an easing of China’s year-long crackdown on its big-tech companies.

As the country faces an increasingly grim economic outlook, regulators have been hinting they may ease their scrutiny of the tech sector.

The Chinese People’s Political Consultative Congress (CPPCC) held a special meeting in May on the digital economy, with Vice Premier Liu

He highlighted the need “to support the platform economy.” This followed similar statements in April, during a Politburo meeting in which leaders vowed to support the “healthy” development of tech platform companies.

In March, the government reiterated its intention to wrap up its crackdown on internet platform companies “as soon as possible”.

Policymakers have also been matching their words with actions to support the sector. China’s gaming regulator recently granted publishing licenses to 60 games, while authorities are also reportedly concluding its probe into ride-hailing giant Didi Global and are preparing to allow its app back on domestic app stores.

In a rare concession, China has also expressed willingness to bring down an audit barrier involving US-listed Chinese stocks.

Valuations of Chinese equities remain attractive

We urge investors to keep faith in China’s equity market. There is obviously a lot to worry about for China, but it is also fair to say that a lot of the negative overhang that has plagued Chinese equities have already been priced-in by the market.

The recent policy pivot towards easing has effectively put a floor under Chinese equities, and thus We believe the market bottom is near.

The valuations of Chinese equities certainly look attractive, with the MSCI China Index having fallen to multi-year lows.

The MSCI China Index is trading at a PE ratio of 10.3x 2024 estimated earnings. Applying our designated fair PE ratio of 14.5X on

EPS projections for the next two years, we project a target price of 101 for the MSCI China Index by end-2024.
This implies a 40.8% upside potential over the next two years.

Our conviction towards Chinese equities has certainly strengthened over the past few months. With the government now signalling that the worst of the regulatory crackdown may be over, for now, and the recent shift in policy stance towards aggressive easing completes our bullish case for one of the worst-performing markets so far in 2022.

If there is ever a good time to enter China’s equity market, it is now.