Positives And Negatives For Chinese Stocks In The Second Half
July is usually a month when trading volumes take a breather as the lull of the summer sweeps across stock markets. This July, the Hong Kong stock market has been especially quiet as investors sat on the sidelines nursing bruises sustained from a violent sell-off in June and watching for indicators of the market’s likely next moves.
Unfortunately, the second half of 2018 is unlikely to be characterized by the clear sense of direction that investors enjoyed in the second half of 2017. More likely, it will be marked by mixed conditions and an attenuation of the volatility that we saw in the first half of the year. Here, we take a look at some of the key positive and negative factors that are likely to tug on Chinese stocks in the next couple of months.
1. Negative: Escalating Trade Tensions
The ongoing trade spat between the U.S. and China – a major antagonist to investor sentiment this year – has shown no signs of abating. In the latest twist, U.S. President Donald Trump is considering raising the level of proposed tariffs on US$200 billion of Chinese imports to 25% from the previously indicated 10%. The move is likely to trigger further retaliatory measures from China, which slapped its own set of tariffs on U.S. goods in early July. While we believe the two sides are likely to eventually resolve the dispute through negotiations, investors are likely to continue to be pinched in the near term as the ongoing spat continues to unleash fear and uncertainty on financial markets. We are also keeping a close eye on how the actual implementation of tariffs will change over time and whether it will lead to any potential disruptions to the operating efficiency and fundamentals of individual Chinese companies. In light of the trade tensions, we have rotated into the education and healthcare sectors, where companies are more immune to global macro risks and benefit from favorable government policies.
2. Negative: China’s Slowing Economic Activity
The latest set of economic data to have surfaced from China did not paint a rosy picture. Industrial output growth slowed sharply in June to 6.0% year-on-year from 6.8% year-on-year in May. The reading also fell well short of the 6.5% year-on-year growth analysts had expected. Worse still, fixed-asset investment growth – an important leading indicator – declined to 6.0% year-on-year in the first six months of the year from 7.5% year-on-year in the first three months as companies grappled with tougher access to financing. The numbers point to a liquidity-induced slowdown in China’s economic activity after authorities adopted measures to rein in credit growth as it looked to deleverage and de-risk China’s financial system. However, the grey backdrop could also present a silver lining to investors. As poor quality companies are weeded out in the deleveraging process, industry leaders are poised to benefit from market consolidation and potentially deliver alpha for disciplined bottom-up stock pickers. Beneficiaries of industry consolidation – including leading real estate developers and consumer goods companies – are a segment that we continue to like.
3. Positive: Favorable Shift in Chinese Government Policy
In light of the squeeze that the deleveraging measures are having on China’s economy, authorities have adopted a more accommodating policy tone in recent days. It was announced at the State Council executive meeting on July 23 that the Chinese government will bolster the real economy through domestic demand expansion and economic restructuring, more proactive fiscal policy and a moderate scale of financing and sufficient liquidity. China’s central bank is also planning to ease some capital requirements for commercial banks, according to media reports. This accommodating shift in policy tone will likely continue to support market sentiment in the second half of the year. However, the long-term prospects for Chinese stocks still hinge upon the government’s implementation of reforms – including expanding domestic demand and tidying up state-owned enterprises – which has been slower than expected so far this year.
4. Positive: Earnings and Valuations
Chinese companies are expected to have a solid interim earnings season this year. The percentage of companies that have issued positive profit alerts has increased to 47% for the second quarter compared to 24% for the first quarter. Sell-side earnings estimates also remain in good shape, with analysts expecting companies on the MSCI China Index to average 16.4% earnings growth in 2018 and 16.0% growth in 2019. Additionally, valuations are supportive, especially after the sell-off in June. The MSCI China Index trades at 12.6 times 2018 estimated earnings, which is below its January high of 14 times and the 18 times at which the MSCI US Index trades.
Disclaimer: The views expressed are the views of Value Partners Hong Kong Limited only and are subject to change based on market and other conditions. The information provided does not constitute investment advice and it should not be relied on as such. All materials have been obtained from sources believed to be reliable, but its accuracy is not guaranteed. This material contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.