Source: AFP
Upgrading our stance on China and Hong Kong equities from Neutral to Overweight
The MSCI China Index has rebounded by more than 20% from its trough in mid-January, entering a technical bull phase, and has significantly outperformed the S&P 500 Index and the MSCI World Index since April to date.
After a sharp rebound, the market is experiencing some profit taking, but we believe that the market recovery is still broadly in an early stage and expect more gains over the medium to long-term.
Downgrading our position in US Treasuries from Overweight to Neutral
Given lower hard-landing risks, a shallower rate cut path and a difficult last mile of inflation, we had raised our forecast for the 10Y Treasury yield from 3.25% to 3.75% in April.
Moreover, with the 10Y US Treasury yield also easing from 4.7% in late April to about 4.5% currently, the scope for further appreciation in long-dated US Treasuries now appears more subdued, especially over the near term.
Long-term risk-reward of China and Hong Kong equities at positive turning point
We believe that the fundamental risk-reward of China and Hong Kong equities has reached a positive turning point.
Firstly, unlike the failed rebounds over the past two years, what is different this time is that negative earnings revision trends for China and Hong Kong equities have likely bottomed out (Exhibit 1). In the current reporting season so far, Chinese companies have mostly beat or met consensus earnings expectations.
Exhibit 1: Earnings revisions have likely bottomed
Sources: I/B/E/S Refinitiv Datastream, Bank of Singapore; updated 24 May 2024
Secondly, to address the property downturn which remains a major market headwind, it is significant that we now see an unprecedented and comprehensive policy playbook addressing key issues relating to:
While it remains to be seen if the current scale of these policies is sufficient, we believe policymakers are ready to further expand the magnitude of execution if needed, especially given that incoming data on the property sector remains weak.
Thirdly, we see increasing policy urgency to boost consumption and growth, including efforts to encourage spending in home appliances and cars etc.
After a prolonged low, consumers are showing more willingness to spend, and the rate of increase in bank deposits has slowed, suggesting reduced cash hoarding behaviour. There are tentative signs of a bottoming out of consumer confidence in some areas, such as the sharp recovery in travel-related spending.
Moreover, we believe that policymakers have dry powder to ease further if needed. Government bond net issuance is set to accelerate in the coming months, and for only the fourth time since 1998, China has announced the issuance of special sovereign bonds, which is supported by the relatively pristine balance sheet of the central government.
Fourthly, in contrast to the situation two years ago, we now have more visibility that the likelihood of a Lehman-style crisis or a major recession is limited. Despite a collapse in housing activity and defaults of major developers, China’s financial system has held up without major stress.
Consensus growth expectations have bottomed out and started to rebound in recent months. Our current base case is that China is likely to meet its 5% growth target in 2024.
Fifthly, positioning factors remain favourable. Short positioning in China and Hong Kong equities remain elevated and could catalyse more upside ahead in the form of short covering in the event of a sustained rally.
Similarly, global fund managers remain significantly underweight in China and Hong Kong equities. As valuations rebound from lows, they have recently begun to add exposure to reduce underweight positions.
Sixthly, the valuations of China and Hong Kong equities remain fundamentally compelling, trading at more than one standard deviation below long-term price-to-earnings multiples (Exhibit 2).
At this juncture, China and Hong Kong equities remain one of the most undervalued markets globally, and we believe their depressed valuations continue to reflect excessive pessimism versus long-term fundamentals.
Exhibit 2: Valuations of China and Hong Kong equities remain compelling
Note: Chart shows the forward price-to-earnings (P/E) ratios of major equity indices based on current prices and blended forward 12-month consensus earnings estimates, vs. their respective 10-year historical highs and lows, as well as levels corresponding to one standard deviation above and below their 10-year historical averages
Sources: MSCI, Bloomberg, Bank of Singapore; updated 24 May 2024
Finally, after a 20% bounce from its recent trough, the MSCI China Index in local currency terms has broken out of major technical resistance levels and entered a technical bull phase. History suggests that China equities tend to show more gains after entering a technical bull phase, with a 60% ex-post likelihood of extending gains.
US-China tensions remain a key concern
One major concern is that US-China geopolitical risks remain ever present in the backdrop, especially as anti-China rhetoric is likely to escalate in the runup to the US election in November.
However, considering that it has been six years since the US-China trade war started in 2018, we see some signs that investors have by now priced in a higher resting heart rate of China-related geopolitical risks.
For instance, the recent announcement of EV tariffs by the US did not trigger an adverse reaction in China and Hong Kong equities, although the same announcement conceivably would have triggered a knee-jerk sell-off one or two years ago.
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