China bull run has investors on edge 

MANY investors are beginning to ponder how much of China’s reopening growth is already priced into the market, following the spectacular rise of the MSCI China index by more than 50 per cent since its October 2022 trough. 

The Hang Seng Index (HSI) and the Nasdaq Golden Dragon China index – a tracker of US-listed Chinese companies – both took a breather from recent rallies after the Chinese New Year (CNY) break, ahead of the US Federal Reserve’s policy meeting this week.

The US central bank had raised rates to over 4.25 per cent from near-zero levels in 2022 in its fight against inflation. This week, it is expected to raise rates further, but by only 25 basis points. 

Despite the pullback, both the HSI and the Nasdaq Golden Dragon China index are up more than 10 per cent and 13 per cent respectively, in the year to date.

News that China’s manufacturing purchasing managers’ index (PMI) rose to 50.1 in January – marking a return to expansionary territory for the first time since September 2022 – failed to impress on concerns about whether the rebound is sustainable.

Stephen Innes, managing partner at SPI Asset Management, reckoned the China reopening optimism is maturing. Investors are now looking for growth to carry the next recovery stage and support corporate earnings.

“It’s too early to tell if the Chinese economy is going to meet and exceed lofty reopening expectations… The question is, will the hard economic data in China bounce to support the huge moves in equities?” he said.

January and February will offer little guidance. The next batch of key data, such as industrial production and retail sales, will be released on a combined basis in mid-March to even out distortion caused by the CNY holiday.

Chinese fund MegaTrust Investment cautioned that the Hang Seng Index (HSI) is overstretched and could drop by as much as 18 per cent from its CNY peak, creating a trap for latecomers betting on China’s reopening. 

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However, Morgan Stanley’s chief China equity strategist Laura Wang viewed the pullback as a buying opportunity, with China’s economy recovering and Sino-US relations stabilising. 

Kinger Lau, Goldman Sachs’ chief China equity strategist, said only “some, but not all” of the reopening growth impulse is already discounted in equity prices.

Lau said the latest China rally was largely in line with the post-reopening recoveries from 36 equity markets globally in terms of duration and magnitude. Further upside will be driven by earnings growth. Goldman is keeping an ‘overweight’ stance on China.

“The larger context is that the MSCI China index fell 64 per cent from its Feb 18, 2021 peak to its fourth quarter 2022 low, and even with a strong rebound, remains 44 per cent below its previous high,” Lau explained.

Even with reduced earnings due to a weak economy and policy-induced pressure on corporate profits, market valuation is still below fair value.

Goldman Sachs raised its 2023 growth forecast to 5.5 per cent from 5.2 per cent, after reports showed activity in December was not as bearish as feared.

Jefferies, too, remains bullish on China. “The China indices in US-dollar terms are ready to break out as the base effects from gross domestic product near doubling should support some of the best earnings per share (EPS) growth globally,” it said. 

Bank of America and JPMorgan Chase also view China’s reopening as a catalyst for a rally in 2023. Paris-based money manager Amundi sees China as a bright spot, with the US and Europe staring at recession amid inflation pressures.

It seems global funds are looking past short-term bumps. So far this year, they have bought close to a record US$20 billion worth of yuan-denominated stocks via the Stock Connect scheme. The amount has surpassed the US$13 billion of net inflows for the whole of last year.

Hedge funds have added risk in China, said Sunil Koul, Goldman Sachs’ Asia-Pacific equity strategist.

Based on Goldman’s proprietary data, their net exposure in Chinese equities has recovered from a low of 7 per cent of the total book to about 13 per cent. That is approaching the 15 per cent peak seen in 2020, just before Beijing’s crackdown on the technology sector.