Despite a promising beginning, 2023 turned out to be another demanding year for Chinese equities, with the MSCI China Index declining by 11.2 per cent.
The decline, however, was solely attributable to multiple compression amid deteriorating investor sentiment, rather than negative earnings growth. In 2024, we believe there are grounds for cautious optimism.
Inflation and monetary policy – from headwind to tailwind
Globally, inflationary pressures have eased, and the downward trend is likely to continue. The US Federal Reserve has confirmed it could look to cut interest rates in 2024. It is likely that we could see similar moves by other central banks.
Despite some monetary loosening in China last year, wider global monetary tightening and disappointment from China’s economic recovery created depreciation pressure for the Renminbi.
This constrained the People’s Bank of China’s flexibility in providing further monetary stimulus to support the economy.
As the cycle starts to turn with US dollar strength weakening, the PBoC will have ample room to loosen monetary policy.
Recent data suggests China’s economy is facing the risk of deflation, therefore further easing is needed and expected as an acyclical measure.
We anticipate that the turning of the monetary cycle will facilitate stronger policy support and believe further required reserve ratio and loan-prime-rate cuts, as well as other forms of easing to improve financing and monetary conditions, will happen.
This should pave the way for a gradual "U-shaped" recovery. Our expectation is for macro conditions to undergo a more pronounced improvement in the second half of 2024.
China’s recovery – delayed, not derailed
While the excitement post-reopening in early 2023 faded quickly on weaker macro-data, the accelerating rollout of policy support measures post-July underscored policymakers’ commitment to economic growth.
In addition to interest rate and RRR cuts, a range of measures were announced, including October’s unexpected RMB1tn (£110bn) central government bond issuance. In recent Politburo and Central Economic Working Conference meetings, Beijing has again communicated a more pro-growth stance.
Prolonged weakness in the property market may continue to be a drag on sentiment. It is critical to watch whether the government will implement further policy support for the property market, particularly concrete measures directed towards easing the pressure on developers facing funding difficulties.
We believe a stabilisation of China’s property market is vital for the sustainable revival of consumer confidence and a further rebound of economic growth momentum.
We expect to see more progress with the government’s comprehensive packages to resolve the ongoing local government debt issue, which has been a major market concern.
This could come in the form of a package of measures and it will be key to monitor whether the central government will leverage up to shoulder this greater debt burden.
Further details may be revealed in the Chinese Communist Party’s forthcoming key economic conference, the "Third Plenum" of the Party Congress.
Geopolitical risks – a continuing source of volatility, priced into markets
Geopolitics should persist as a key contributor to market volatility. However, we believe these risks are currently priced into the valuation of Chinese equity markets.
While one-third of the global population goes to the polls this year, the most notable elections for China are November’s US presidential election and those held in Taiwan on 13th January.
In Taiwan, while Lai Ching-te won the presidential election, his Democratic Progressive Party lost their majority in the "Legislative Yuan".
This outcome provides for a "check and balance", thus preserving the existing status quo between the island and Beijing.
Consequently, there was minimal market reaction post-election, a factor that could be construed as a "positive" development.
With the commencement of the US election campaign, we should expect increasing news flow on Sino-US relations, given that a strong stance on China continues to be a bipartisan consensus in the United States.
However, recent efforts by both parties to move towards a normalisation of relations are a welcome and positive step.
In conclusion, we maintain a cautious optimism towards Chinese equities, anticipating a more substantial market recovery during the second half of the year.
With a 12-month forward P/E ratio of 10.2x*, the MSCI China Index is currently trading nearly one standard deviation below its 10-year average.
Valuations of Hong Kong equities are even more depressed, with a 12-month P/E ratio of 8.8x* for the Hang Seng Index, corresponding to two standard deviations below its 10-year average.
Assuming there are no substantial revisions to earnings and a return to long-term valuations through mean reversion, this scenario could lead to an approximate 20 per cent upside for the MSCI China Index and a 30 per cent upside for the Hang Seng Index.
This positions long-term investors with an appealing entry point and serves as a buffer against further significant downside risks.
David Townsend is managing director of the EMEA Business at Value Partners Group