By Janet Mui, head of market analysis at RBC Brewin Dolphin
We have now entered the year of the dragon in the Chinese zodiac – a magnificent and mystical creature symbolising supernatural power and prosperity. As the most auspicious of all zodiac signs in Chinese culture, could the year of the dragon bring a change of fortune for China?
We believe 2024 is likely to remain an uphill battle for the Chinese economy and its markets.
To avoid being overwhelmingly pessimistic on China, let’s think about the potential positive developments in 2024.
The authorities have stepped up stimulus measures and are increasingly pre-emptive and targeted in nature. At some point, they may well develop a “whatever it takes” attitude.
For example, in an unprecedented move, China’s central bank announced an impending cut in the reserve requirement ratio (the percentage of deposits that a commercial bank must hold in reserve) ahead of its official meeting date. There is also a clear signal of further easing measures to come. Consideration of a stock market stabilisation fund shows the authorities will not turn a blind eye to the haemorrhage in Chinese stocks.
China has also backtracked on measures aimed at deterring online gaming companies, which shows increased consideration for how regulatory changes can impact market sentiment. The risks of a regulatory crackdown remain, but the worst is probably behind us.
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The external demand picture for China may look brighter too, with interest rates likely to be cut and an increased probability of a soft-landing in major economies in 2024.
Low Chinese asset valuations due to the depressed sentiment around China could also pique investors’ interest – could “be greedy only when others are fearful” apply to how investors view China?
The problem with the investment philosophy widely celebrated in the West is that it is not always applicable in China. The reason why? China is still a centrally directed economy and the state has tightened its grip on private companies in recent years.
Being a shareholder may not equate to participation in the future success of a company, for example. Instead, shareholder capital may be used to serve the policy goals of the Chinese government and underwrite the risk in the process.
True, there are some secular bright spots in relation to industrial upgrades, artificial intelligence (AI) and de-carbonisation. Electric vehicles (EV) and solar panel production are booming, and China will be a key player in the world’s transition to renewable energy. Progress has been swift, perhaps best seen in BYD (Build Your Dreams) overtaking Tesla as the world’s biggest EV producer in 2023.
However, investors exposed to a broad equity index in China may find it difficult to benefit from these themes. The top ten constituents of the CSI 300 Index are dominated by state-owned banks and insurance companies, whereas the Hang Seng China Enterprise Index has a heavy weighting to Chinese technology giants, which remain under scrutiny due to national security.
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Even if you target the companies that may benefit from secular tailwinds, many Chinese companies that produce and supply to the world’s renewable energy sector are heavily state-subsidised and are not necessarily profitable. These industries may also be challenged by the increasingly protectionist stance of the West, which may become a focal issue for the China hawks in the upcoming US election. During the US-China trade war under Donald Trump’s presidency, Chinese equities significantly underperformed those in the US.
Simply put, economic confidence in China will be steered by the property sector in 2024. The liquidation order of Evergrande will be complicated and investors will have to wait years to retrieve assets. Crucial to sentiment recovering will be whether unfinished residential units are completed for homebuyers who have already paid. Chinese authorities and Evergrande have made this a priority but it is worth watching how this one unfolds.
While there are goals to channel more funding into the property sector, it is hard to anticipate a major recovery in 2024, as banks have remained cautious and selective in their lending. Not helping matters is the expectation that refinancing pressures will remain high for property developers in 2024 and 2025, according to Moody’s.
Unless there is a revival in the property market, consumers’ appetite to spend may be limited, especially given around 70% of Chinese household wealth is tied to property. The property crisis also highlights the wider difficulty in rebalancing China’s economy from one driven by fixed investments to an economy deriving growth from consumption.
Against this backdrop, it is unsurprising that Chinese equities have become very cheap. After falling in seven of the past 10 years, it is unlikely to see further big drawdowns in 2024. That said, for markets, it is going to take a lot more than the prospect of easing and better economic data to turn their entrenched negativity around. China could really do with the year of the dragon living up to its name.
