Strategy Note /

China's pragmatic policy turn signals an end to self-harm

  • From zero-Covid to re-opening as Xi responds to protests; good for China, linked manufacturers, commodity exporters

  • Add in real estate sector support and a potential 5% growth target for 2023 and pragmatic policy turn is evident

  • MSCI China and CSI 300 indices are up c20% from end-October low; still on 5-10% PE discounts versus the five-year median

China's pragmatic policy turn signals an end to self-harm
Hasnain Malik
Hasnain Malik

Strategy & Head of Equity Research

Tellimer Research
7 December 2022
Published byTellimer Research

General Secretary Xi Jinping appears to have responded to recent protests by finally loosening the zero-Covid policy.

The changes are not being applied consistently, the timing for a full normalisation remains unclear, and infections and hospitalisations will no doubt increase (albeit detection is likely to decrease with less stringent testing).

But the direction of change towards fewer lockdowns is clear.

China Covid detections may drop with less testing

When added to greater state support for the distressed real estate sector (eg loan and repayment extensions, allowing eligible developers to raise equity finance and pursue M&A) and the potential target of 5% real GDP growth for 2023 (compared with the 4.4.% IMF forecast), according to Bloomberg reports, this signals a shift back to pragmatic over dogmatic policy.

The real interest rate is still positive, at 0.7%, and, therefore, the capacity for policy stimulus remains.

China real GDP growth deceleration

The long-term outlook for China, with all the attendant social, economic and geopolitical risks that have dominated the investment debate in recent years, has not changed. But, at least, the worst may have passed from self-destructive policies.

China summary of top-down equities positives and risks

Whatever gets China going is positive for the rest of the world

The implications are also positive for interlinked manufacturers (eg Vietnam, where Chinese imports account for around one-third of GDP), commodity exporters (from Saudi Arabia and the GCC in crude oil, to Chile and Peru in copper) and tourist markets.

China deeply interconnected with Asian EM manufacturing

Time to revisit for foreign investors

Foreign outflows from locally listed Chinese equities to the end of September 2022 reversed the inflows of the prior year and a half. A shift back to pragmatic policy may persuade some to revisit. China has merely a 4% weight in the MSCI ACWI equity index, compared with its 10% and 19% shares, respectively, of global market capitalisation and GDP.

For others, the risk of an expansion of US sanctions, the dominance of the agenda of the Communist Party over that of the private sector and minority shareholders, and ESG concerns (however inconsistently applied) have taken China off the radar permanently. A sustained re-rating, whether driven by local investors (the forward dividend yield of 2.5% compares favourably with the local currency government bond yield of 2.7%) or foreigners, may test the conviction of these views.

China's year of huge foreign outflows from equities

Chinese equities, measured by MSCI China (Tech stocks Tencent, Alibaba, Meituan, JD, Baidu and Netease collectively make up almost one-third of the index) or the Shanghai Shenzhen CSI 300 (locally listed A-shares) are up c20% since the end of October 2022 low.

Both are still down over 20% year to date.

  • MSCI China is on trailing PB of 1.3x (for 10% ROE), a 22% discount to the five-year median, while forward PE is 12.2x (alongside 2.5% dividend yield), a 10% discount to the five-year median.

  • CSI 300 is on on trailing PB of 1.8x (for 12% ROE), a 4% discount to the five-year median, while forward PE is 13.5x (alongside 2.5% dividend yield), a 3% discount to the five-year median.

  • Hong Kong's HSI is on on trailing PB of 1.1x (for 9% ROE), an 8% discount to the five-year median, while forward PE is 11.0x (alongside 3.4% dividend yield), a 7% discount to the five-year median.

  • The Chinese renminbi real effective exchange rate is at its 10-year median.

China and HK equities cheaper than US and EM peers

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