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

Will 2022, the year of the tiger, be kinder to investors in Chinese stock markets?

 

A Better Year Doesn’t Necessarily Mean a Good Year

There are many headwinds from 2021 that will continue to affect China’s economy and stock market in 2022. Not least of these will be the impact of China’s zero-COVID-19 policy on consumption and industrial production. Even so, the country is seeing a continued slowdown in construction (particularly in the residential sector) alongside sluggish income growth. It’s also facing a potential slowdown in exports, as economies around the world reopen and service activities accelerate (e.g., less widgets, more holidays).

Retail-sales growth in China has been slowing after the initial post-COVID-19 spike, and disposable-income growth is also declining (FIGURE 2). The potential for widespread job cuts in sectors such as technology, education, and construction could further weaken consumption numbers.

 

FIGURE 1

China Export Growth Has Been the Bright Spot—But Is It Now Set to Slow as Demand Switches to Services and Prices Normalize?

China’s Trade Growth

% year-over-year (yoy), 12-month rolling sum

Export Growth

%yoy, 3-month rolling sum

Implied Price of Exported Products*

%yoy, 3-month rolling sum

* Derived from export value and volume in the chart on the left. Sources: CEIC, Autonomous Research, January 2022.

FIGURE 2

Retail Sales Numbers Are Weakening After the Post-COVID-19 Jump

Official Monthly Retail Sales Growth*

%yoy

Monthly Contribution to Retail Sales Growth

%yoy, adjusted for 2018 revision

* Series was revised in 2018, with some entities taken out. ** Enterprises with annual main business revenue of CNY20mn or more. Sources: CEIC, Autonomous Research, January 2022.

 

Government’s Policy Reset Will Be a Major Headwind in 2022

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

New policy initiatives include:

  • Common prosperity, which aims to make society fairer and spread the benefits of growth more evenly;
  • Definancialization, which is the reduction of financial risks posed by excessive debt-fuelled speculation in property and other financial assets;
  • Regulation of data, which aims to ensure that personal data is not misused or monopolized; and
  • Dual circulation, which aims to shield China from global volatility and pivot the economy toward greater self-reliance.

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

 

Unlike many past policy pronouncements, we see these new initiatives as real and part of a conscious effort to reshape society.

 

State Priorities vs. Shareholder Interests

In the Chinese stock market, the investment focus of many constituent companies is aligned with state priorities rather than focused on maximizing long-term shareholder returns. This has applied to most state-owned banks, utilities, telecom, and 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 begin putting 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 in place of building huge monopolistic data platforms or investing in ever-cheaper community group-buy programs that put small shops out of business.

While this may be good news for the average Chinese citizen, it may not be 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 impacted companies less attractive.

 

Haven’t We Been Here Before?

China has been through this twice before when telecom and bank stocks listed, which in their euphoric heydays were around 50% of the MSCI China Index1 by market capitalization. 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 the market has not fully digested the long-term implications of the policy changes affecting many sectors of the Chinese stock market.

On a more positive note, we expect further cuts to interest rates, although nudging five basis points2 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 benefits). This could 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 doesn’t mean we expect a strong, sustainable recovery in Chinese stock markets—the economic and earnings outlook is difficult for many sectors, and the risk of a more significant economic slowdown in China looks tangible.

 

Talk to your financial professional to learn more about investment opportunities in China.

 

1 MSCI China Index is a free-float adjusted market-capitalization index that is designed to measure equity market performance in China.

2 A basis point is a unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly used for calculating changes in interest rates, equity indexes and the yield of a fixed-income security.

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Insight from sub-adviser, Schroders Investment Management
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Co-Head of Asian Equity Alternative Investments

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