People’s Bank of China Fires the Bazooka
In pursuit of its 5% growth target, the People’s Bank of China (PBOC) recently announced various monetary stimulus measures to fuel the economy and improve consumer confidence. Of the most notable initiatives to boost lending and market liquidity, the reserve requirement ratio (RRR) for major Chinese banks was lowered by 0.50%, existing mortgage rates were lowered by 0.50%, and lowered the Seven-Day Reverse Repo rate by 0.2%. In addition, the PBOC implemented a new borrowing facility that financial institutions can leverage to buy stocks or bonds. In our view, this could be just the beginning in terms of stimulus measures in China, with market participants anticipating that the PBOC could further lower the RRR and various interest rate benchmarks before year end.
Chinese Equities Reaction Was Initially Positive
Chinese equities responded positively to the PBOC’s announced measures. From September 23 to September 26, the Shanghai Stock Exchange Composite Index and the Hang Seng Composite Index have both moved up 9.2%. The momentum has been relatively broad with the percentage of stocks making new highs improving as well. The Shanghai Composite Index saw just over 50% of its 2,229 constituents trade to a one-month high while the Hang Seng Composite saw about 60% of its 517 members hit a one-month high on September 25.
Valuations are Cheap and Sentiment is Poor
The positive price action from Chinese equities is a welcome sign to investors that the nascent stages of a change are underway. Due to pervasive neglect and investor aversion, the bar of expectations for Chinese equities is low. Sentiment likely cannot get much worse and China stock valuations reflect this pessimism. The MSCI China Index is trading at 8.9x next twelve month (NTM) estimated earnings. When China’s NTM price to earnings (PE) ratio is compared to MSCI All Country World, Chinese equities are trading at a historically depressed discount of half the MSCI All Country World Index’s 17.9x NTM PE ratio. For value investors, there could be an opportunity here.
Earnings Expectations are Subtly Improving
Earnings expectations are quietly improving as well. Annual earnings estimates for 2024 and 2025 have been slowly moving higher after bottoming in the second quarter of 2024. That being said, there remains a significant amount of work to be done before signaling all-clear and confidently calling a bottom.
Headwinds Remain
While the monetary stimulus measures are a welcome development for Chinese equities, headwinds persist. Whether the PBOC’s initial measures to stimulate growth, enhance liquidity, and inspire investor confidence remains to be seen. Broadly speaking, China still faces structural headwinds to its economy through its real estate market and geopolitical risks.
The China Dragons
Given the headwinds of various magnitudes for China from both an economic and market perspective, targeted exposure to select Chinese mega-cap tech companies could be a prudent approach as these companies achieve competitive advantage through economies of scale, solid fundamental footing, and extraordinary growth relative to their peers.
Tencent, Pinduoduo, Alibaba, Meituan, BYD, Xiaomi, JD.com, Baidu, and NetEase – which Roundhill have dubbed the “China Dragons” – represent not only clear leadership as technological innovators within the Chinese economy but global market presence given the influence of their cutting edge technology.
The Trade for China Going Forward
From an economic perspective, China is experiencing serious headwinds that have hampered growth and consumer confidence. These problems will not disappear overnight, despite the PBOC’s stimulative measures actively being deployed. However, there are still opportunities for investors in Chinese equities.
Historically compelling valuations, subtly improving earnings estimates, and impressive price momentum are potential tailwinds, but more is needed before a full embrace of Chinese equities is warranted. To capitalize and trade the recent bullish news from China, targeted, concentrated exposure to the promising innovation of the China Dragons could be the key. The China Dragons may provide leverage to the prospective acceleration in economic growth and improvement in the Chinese consumer while managing the broader risks of China.
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Glossary:
The MSCI China Index is a free-float weighted equity index. It was developed with a base value of 100 as of December 31, 1992. This index is priced in HKD.
The MSCI ACWI Index is a free-float weighted equity index. It was developed with a base value of 100 as of December 31 1987. MXWD includes both emerging and developed world markets.
The Shanghai Stock Exchange Composite Index is a capitalization-weighted index. The index tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange. The index was developed on December 19, 1990 with a base value of 100. Index trade volume on Q is scaled down by a factor of 1000.
The Hang Seng Composite Index is a market-cap weighted index that covers about 95% of the total market capitalisation of companies listed on the Main Board of the Hong Kong Stock Exchange. The base value of the index is 2000 on base date of January 3rd 2000. HSI started to price this index end of day March 8th.
