Perspective

Will the Tiger outdo the Ox?


The Chinese year of the Ox, 2021, was a difficult year for investors in China. The year was dominated by major regulatory change, debt defaults in a sharply weakening property sector and a tight credit market.

So, will 2022, the year of the Tiger, be a better year for Chinese stock markets?

A better year does not necessarily mean a good year

There are many headwinds from 2021 that will continue to affect China’s economy and the country’s stock market in 2022. Not least of these will be the impact of China’s zero-Covid-19 policy on consumption and industrial production. But also, the country is seeing a continued slowdown in construction (particularly in the residential sector) alongside sluggish income growth.  

Meanwhile, China also faces a potential slowdown in exports, as economies around the world reopen and service activities accelerate (for example, less widgets, more holidays).

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Retail sales growth in China has been slowing after the initial post-Covid spike and disposable income growth is also now declining (see charts below). The potential for wide-spread job cuts in sectors such as technology, education and construction could further weaken consumption numbers.

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Government’s policy reset will be a major headwind in 2022

China’s policy “reset”, as the government tries to rein in some of the policies it sees as contributing to widening income inequality, rising debt levels and social disorder, is ongoing. It will continue be a major headwind for the country’s stock markets in 2022.

There are four main new policy initiatives. These include Common Prosperity, which aims to make society fairer and spread the benefits of growth more evenly. Another is Definancialisation, which is the reduction of financial risks posed by excessive debt-fuelled speculation in property and other financial assets. Thirdly, Regulation of Data, which aims to ensure that personal data is not misused or monopolised. And, finally, Dual Circulation, which aims to shield China from global volatility and pivot the economy towards greater self-reliance.  

This reset could be seen as curbing the excesses of unfettered capitalism and, unlike many past policy pronouncements in China, we do see these policies as real and part of a conscious effort to remould society.  However, the main issue for the stock market returns is how these policies are implemented.

State priorities vs shareholder interests

In China, we have a stock market where the investment focus of many of the constituent companies are aligned with state priorities rather than a goal of maximising long term shareholder returns. This has clearly applied to most state-owned banks, utilities, telecom, energy stocks for some time. However, with the new policy push to ensure common prosperity and social harmony we expect education, healthcare, insurance and social media companies to put state policy priorities first (or as in the case of education stocks be told they are now a non-profit sector).

For the large internet stocks, the priority now appears to be helping with common prosperity projects and investing in areas outlined under dual circulation. This is rather than building huge monopolistic data platforms or investing in ever cheaper community group buy programmes that put small shops out of business.

While this may be good news for the average person in China, it is clearly not such good news for stock markets and foreign investors. We believe the move to state/policy-directed investment will lower return on invested capital (ROIC) in China and make shares in those companies affected less attractive

Haven’t we been here before?

We have been through this twice before in China. This was when the telecom and bank stocks listed which in their euphoric heydays were around 50% of the MSCI China by market capitalisation. For a while the market thought these stocks would be great proxies for strong GDP growth and thus make exceptional returns. However, state control, as it does in most countries, has led to a different set of priorities and poor ROIC and share prices.

Although this doesn’t make Chinese stocks uninvestible, we believe that the market has not fully digested the long-term implications of the policy changes affecting many sectors of the Chinese stock market.

However, on a more positive we expect further cuts to interest rates, although nudging 5 basis points (bps) off short-term interest rates, as we saw in December, may not have any real impact.

We also don’t believe that the property sector slowdown will have major ramifications for the broader financial sector given the ability of the Chinese government to contain the problems (controlling major banks and state-owned developers has its uses). This should also mean the impact on consumer confidence from the property slowdown remains limited.

In summary, we don’t expect to see a repeat of the headwinds that wreaked havoc in the Chinese stock market in 2021. However, that does not mean we expect a strong sustainable recovery in Chinese stock markets – the economic and earnings outlook is difficult for many sectors, and the risks of a more significant economic slowdown in China look real. 

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