Chinese equities have continued where they left off in 2023 with the Hang Seng Index (HSI) already down 8% in the new year. China stocks extended their decline as disappointing economic data and Premier Li Qiang's comments on avoiding massive stimulus weighed on the market.
The Hang Seng Tech Index in Hong Kong recorded its largest two-day drop since October 2022, while the NASDAQ Golden Dragon China index hit its lowest point since November 2022. Economic concerns persisted with a significant fall in China's property sector, witnessing the steepest decline in home prices in nearly nine years.
Moreover, deflation risks increased as a measure of broad price changes experienced its lengthiest stretch of quarterly declines since 1999. Premier Li Qiang emphasized in Davos that China refrains from employing massive stimulus to drive economic development.
Difficult Macro Conditions Still Weigh on Risk Sentiment
China's economy faces ongoing challenges, which has started to prompt pro-growth policy initiatives. Anticipating GDP growth around mid-4% in 2024, the government aims to strengthen fiscal stimulus, especially with persistent property market weaknesses. Many investors and analysts expect accommodative monetary policies to persist.
China's economy rose 5.2% in the fourth quarter from a year earlier, according to the official data released on Wednesday. Analysts were looking for +5.3%.
"The full-year numbers were in line with expectations but the December numbers were mixed. Overall, I think the data, especially from the property side, is not looking good. Property sales weakened worse than November levels,” said Woei Chen Ho, an economist at UOB, Singapore.
"I think markets were disappointed they didn't cut interest rates on Monday, but it seems they are thinking about more targeted measures. The property issues are not fixed by broad-based rate cuts."
Additional central government-backed funding, such as pledged supplementary lending (PSL) and special bonds for urban village renovation and affordable housing programs, will likely provide support.
Progress in local debt restructuring is also on the agenda. A potential pivot by the US Federal Reserve (Fed) could ease pressure on the CNY's depreciation, allowing the People's Bank of China (PBOC) room for incremental policy rate cuts to navigate economic uncertainties.
The annual Central Economic Work Conference in December acknowledged the "insufficient demand" in the real economy and maintained a pro-growth stance. However, it did not provide significant surprises or new details on addressing property and local debt challenges. These events have contributed to the weakness in China's stock market.
The upcoming National People’s Congress on March 5th will be crucial, unveiling the Government Work Report with specific economic and policy targets for the year. To achieve a growth target closer to 5%, stronger policy responses, including monetary, fiscal, property, and local debt measures, may be necessary.
The late-year extra fiscal spending, particularly the issuance of a CNY 1 trillion special central government bond (CGB), indicates a potential escalation of fiscal support for the economy. The fiscal deficit for FY2024 may be targeted at around 3.5% of GDP.
With the positive impact of the special CGB issued late last year, the fiscal impulse is expected to be more growth-supportive compared to the previous year. This could provide a major boost for the embattled stock market.
Moreover, monetary policy is likely to remain accommodative, responding to lingering deflationary pressure and challenges in the property sector. The dovish stance of the Federal Reserve and recent deposit rate cuts may afford the People's Bank of China (PBoC) some flexibility to implement incremental policy rate cuts.
Answering the question why is China not cutting rates aggressively, Jefferies analyst Shujin Chen said this week:
“We see a rate cut possible but not a must in 1Q24 due to: 1) limited room for rate cuts, considering banks' NIM, capital and resilient deposit rate; 2) limited impact, considering strong TSF & loan and significant decline in new loan and bond yield in 2023; & 3) likely shift to credit structure than quantity in 1Q24.
“China needs banks to boost loan and total social financing (TSF) as a part of social responsibility. Core tier-1 capital (mainly common equity) could be a bottleneck in the long run.”
Valuations Depressed – Buy the Dip?
The HSI is now trading more than 50% off its record high set in 2018. The greatest issue for investors looking to buy China stocks is the fact that the market is responding with great urgency to the government’s proposed changes and actions.
However, the sentiment could drastically change in the event of more supportive policies. In this case, a preference would be given to growth stocks that are responsive to the macroeconomic recovery, particularly within the internet and consumer sectors, along with cyclical sectors.
“We suggest continuing with a defensive tilt in investors’ Chinese equity exposure with a focus on sectors like consumer staples, utilities, select larger state-owned lenders, and telecommunications,” UBS analysts wrote in a note.
Looking ahead to the medium to longer term, aligning investments with China's emerging investment drivers amid a decelerating growth environment could be the base case for many investors. Stocks in sectors such as autos, consumer goods, healthcare, technology, and online gaming could stage a solid bounce.
For China stocks to bounce, investors will be watching closely developments related to these potential catalysts: the tangible execution of policies (particularly in property easing), initiatives to stimulate consumption, support for the private sector, etc.
Summary
A slew of disappointing economic data has exerted continued pressure on China equities. From now on, investors will be watching whether further initiatives are executed swiftly to tackle apparent economic issues. Valuations are already supportive with the Hang Seng Index trading at 15-month lows.
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Shane Neagle is the EIC of The Tokenist. Check out The Tokenist’s free newsletter, Five Minute Finance, for weekly analysis of the biggest trends in finance and technology.