China’s economic data have underwhelmed lately after a strong start to the year, dragging Asia ex-Japan asset returns. This has also raised doubts about the sustainability of the post-pandemic rebound. We see some durable green shoots: consumer-driven activity is picking up as pent-up demand is met, reviving corporate earnings across services industries. China’s overall earnings outlook for 2023 looks much stronger than those for the US and Europe. Also, Beijing continues to provide policy support to revive growth, in contrast with tightening policy stances in the US and Europe. Moreover, China’s USD bond and equity valuations remain inexpensive. Standard Chartered believes the case remains for retaining exposure to China assets within a diversified Asia ex-Japan and global allocation.
Underwhelming April data: China’s manufacturing sector and exports remain weak primarily due to a slowdown in economic activity in its main export markets in the US and Europe. Property-related sectors remain under pressure due to structural weakness caused by the overhang of inventory and depressed housing market sentiment. Even retail sales growth fell short of estimates, despite sustaining the y/y growth momentum from last year’s low base.
Some green shoots: However, the house highlights some encouraging signs that consumers are willing to spend their excess savings accumulated during the pandemic. The latest May “Golden Week” holiday spending exceeded pre-pandemic levels – this is likely to show up in the retail sales data for May. Several regional governments have unveiled incentives to boost consumption of big-ticket items such as cars and consumer durables. Even the depressed housing market is showing some signs of revival as authorities ease mortgage rules to entice first-time buyers. New home sale prices have risen month-on-month for the third straight month. At the latest Politburo meeting, authorities continued to focus on targeted measures to revive growth, jobs, and private investment.
Strong earnings outlook: The post-pandemic revival in the economy is filtering through to strong corporate earnings, especially in consumer-oriented sectors. In Q1, the Bank said its preferred consumer discretionary and communications services sectors delivered positive earnings surprises, with a strong outlook for the rest of the year. The strong guidance has led to upgrades to 2023 earnings estimates, compared with downgrades to US earnings. Also, China’s 2023 earnings estimates remain significantly stronger than those in the US and Europe, primarily due to base effects as the economic reopening lifts revenue.
Attractive valuations: The Bank believes China’s relatively stronger growth and earnings outlook is not reflected in the pricing for its stocks and USD-denominated bonds. Given China’s significant weight in Asia ex-Japan and Asia USD bond indices, this undervaluation is also reflected in Asia ex-Japan assets. For instance, the MSCI China equity index is valued at 10.4-times 12-month forward earnings, compared with 18.4x for MSCI US and 12.2x for MSCI Euro area. The MSCI China index is trading at a 34% discount to the MSCI All Country World index, compared with an 18% average discount over the past 20 years. We believe the primary driver for this undervaluation is geopolitics as the US proceeds with measures to curtail access of cutting-edge technology to China. However, we have seen positive overtures lately from the Biden administration to engage with China policymakers for talks. SC expects the valuation advantage for China and Asia ex-Japan assets to come to the fore as extreme geopolitical worries subside.
Investment implications: Against this backdrop, the SC investment sees an opportunity to use the recent weakness in Asia ex-Japan assets to build exposure. We remain overweight on the region’s stocks and bonds within our foundation allocations. The house is particularly bullish on Asia USD bonds on a 12-month horizon, given the asset class’s predominantly investment grade feature and low volatility. Within China equities, the strong Q1 earnings provide us more conviction in the consumer-based equity sectors: consumer discretionary and communications services.
Commentary from SC Bank
