A giant leap into the Year of the Rabbit
China’s earlier and faster than expected reopening is going to boost domestic GDP growth. The dramatic U turn in Covid strategy, along with better liquidity support for the property sector; short term improvements in geopolitics, favourable news on ADRs listing rules, and friendly policies for the private sector dominated internet sector have completely turned sentiment. This has led to a strong bounce in the Chinese equity market as risk premium comes down. In December 2022, it was dangerous to be underweight China, now China is expected to be an outperformer in the Year of the Rabbit.
Hop, hop, jump to a better 2023 for China
Covid cases in China nationally should peak after the Chinese New Year in early February. They may have already peaked in Tier 1 cities. There could be new waves of cases throughout 2023, but the negative impact should be minimal as observed in other economies that reopened. In other words, there should be no turning back. China economy is opened.
Once the Covid situation in China stabilises, recovery in China should accelerate and better economic data can be expected from 2Q 2023, or maybe even earlier. The expectation is that growth is driven by consumption and a pick-up in services. The government is prioritising growth in 2023 and should support the economy with stimulus. Consumption coupons are likely to be distributed in certain areas from now until May 2023. Investment will continue not only in infrastructure but also in the low carbon economy. Solar and wind investment should increase and perhaps a carbon tax will be imposed. Urbanisation remains a key driver as China strives to bring urbanization rate up to 80% from the current 63%. Economic data points should pick up over the current months and potentially exceed forecasts.
This year growth momentum may surprise on the upside due to the reopening and the low base effect, with the pent-up demand from the consumer and opening up of services as the main growth driver. However, the growth rate trend is likely to normalize and reach a lower equilibrium going forward. In the medium-term, the Chinese economy and market could face the same challenges prior to covid as the same uncertainties such as common prosperity, self-sufficiency, property weakness, and geopolitics, remain.
The rapid ease of China’s zero covid policy in December 2022, in contrast to gradual re-opening in many countries, has led to a strong rally for the Chinese equity market. The recent rally is driven by a combination of these factors: (1) reopening, (2) friendly policies for the private sectors i.e., Internet and Healthcare; (3) ease of borrowing restrictions for property developers and fine-tuning of the “three red lines” policy (4) a much calmer US and China relationship in the past few months, and (5) positive result from PCAOB audit inspection in December 2022 with regards to ADR delisting.
So the question is, has the Chinese equity market gone up too much? DWS believes there is still a lot more to go. The Chinese equity market has come down a long way since February 2021 and has only caught up a bit in recent rally. With the positive developments in China, risk premium has fallen, and the Chinese equity market is re-rating with the price-to-earnings ratio rebounded to 11.9x from a historical low of 8.2x in October 2022.
Investors’ positioning from global funds stay light after they reduced their positions last year. Foreign investors remain unsettled by the covid situation in China and have adopted a wait-and-see approach on reopening. There are concerns over the surge in infection cases and the potential disruption to global supply chains. These concerns should dissipate quickly when economic data in the next few months show that there is limited disruption to production and the mobility within China recover rapidly. China could have a quicker recovery than expected.
Prosperity and Abundance awaits us
According to the Chinese astrology, The Year of the Rabbit will bring success and peace. The new year should be a good year for China with a better economy and earnings outlook in addition to a more peaceful environment for geopolitics and the private sector in China.
In terms of macro-environment, both fiscal and monetary policies are neutral to slightly loose, and the pent-up consumption should lead to a GDP growth of 5%. On the other hand, global markets’ growth pale in comparison. Growth in Developed market is expected to be anaemic, and monetary policy continues to be tight as inflation stay high.
In terms of the Chinese equity market, earnings growth of about 15%, together with lower risk premium should bode well for the Chinese equity market. Valuation of Chinese equities is also attractive at 11.4x forward price-to-equity ratio, lower than 10-year average of 13x. The consumer sectors are most well-placed to benefit from China’s reopening. After three years of lockdown, there is strong pent-up demand and excessive household savings which could lead to a retaliatory consumption in 2023. While China’s economic reboot could be rocky and non-linear as the public health crisis plays out remains to be seen, the worst should be behind us, as prosperity and abundance awaits investors in 2023.
