Look east: Hong Kong and China equities at inflection point

THIS June, more than 13 million students sat China’s 2024 national college entrance exam (or gaokao). China market participants have been facing a similar test of perseverance, as they wait to see to whether the sharp rebound in its equity market will prove short-lived, like the stop-start market rebounds of the past two years. Will it be more durable this time?

Over the past three months, the MSCI China Index rebounded by over 20 per cent from its mid-January 2024 trough, entering a technical bull phase that significantly outperformed the S&P 500 index and MSCI World Index. Despite the recent pullback in China and Hong Kong markets from profit taking in May, we believe this market recovery is in its early stages and poised for gains over the medium to long term.

We recently upgraded China and Hong Kong in our equity strategy to “overweight”, as the fundamental risk-reward of China and Hong Kong equities has reached an inflection point. Our confidence is driven by the following:

• Macroeconomic recovery is on track. China’s economy remains on track to meet our forecast of a solid 5 per cent growth this year. But its post-pandemic recovery is still unbalanced against a backdrop of cautious consumers, indebted local governments reticent about raising borrowing and a nascent property market recovery.

• Policies to boost consumption and growth. China policymakers have dry powder for further easing, as government bond net issuance is set to accelerate in the coming months. Only for the fourth time since 1998, China has announced the issuance of special sovereign bonds, such as the one-trillion-yuan (S$186.4 billion) issuance of ultra-long government bonds for strategic investments.

• Unprecedented real estate policy playbook. While the property downturn remains a major drag, China announced a comprehensive suite of measures in May, including easing of its rules on purchases and removing the floor on mortgage rates to address key issues of weak demand, excess supply and sector liquidity in the real estate sector. One of the most significant is 500 billion yuan in loans; of this amount, 300 billion yuan will be funded by The People’s Bank of China’s relending facilities through 21 national banks for local governments to purchase unsold completed properties from developers for affordable social housing. While the jury is still out on the scale and efficacy of the current policies, we believe policymakers stand ready to expand the policy magnitude, especially if incoming residential property transaction volumes and prices remain weak in the run-up to the Third Plenum in July.

• Supportive capital markets regulations. The “five measures” announced by Chinese regulators to boost capital markets are supportive of Hong Kong as a regional financial centre. They include expansion of ETF Connect, inclusion of real estate investment trusts in Connect, onshore HKD-RMB Dual Counter launch and further mutual recognition of funds. Potential further inflow of domestic funds can improve Hong Kong’s liquidity over the long run. 

• Investor positioning and technical factors. China equities tend to outperform after entering a technical bull phase, with a 60 per cent ex-post likelihood of extending gains. Global fund managers who had been underweight Asian markets have also started to rebalance in favour of Asian stocks in recent months, on the back of attractive valuations and improving fundamentals.

• Geopolitical risks and US-China uncertainties. US-China geopolitical risks remain a concern, but given the experiences of the past six years since the US-China trade war started in 2018, investors have by now priced in a higher resting heart rate for US-China related geopolitical risks. However, in the run-up to the first debate between President Joe Biden and ex-president Donald Trump on Jun 27, financial markets may be volatile in pricing the likely effects of a second Trump term.

Asia opportunities in H2 2024

Against global market uncertainties, Asia offers diversification for investors seeking exposure to longer-term structural themes. They include access to a growing middle class, the prospects of near-shoring, rebuilding of supply chains and intra-Asian trade amid US-China geopolitical uncertainties. Infrastructure investments to support climate resilience, artificial intelligence (AI) innovation and social infrastructure also offer investors a wealth of opportunities.

• Invest in key China equity themes. Within China equities, we remain selective and favour undervalued names that provide exposure to broad themes including AI, large market leaders and quality yield names.
• Upgrading Asia ex-Japan equities. In our overall equity asset allocation, we upgraded our Asia ex-Japan positioning as a result of our preference for China and Hong Kong. The downward earnings revision cycle for the MSCI Asia ex-Japan Index has likely bottomed. We expect earnings per share (EPS) growth of 23 per cent in 2024 and 16 per cent in 2025, led by South Korea, Taiwan, India and China.
• Japan’s structural drivers versus short-term volatility. While we remain positive on Japan’s equity market on improvements in corporate governance, share buybacks and dividend increases, currency volatility is a key risk as the Bank of Japan (BOJ) stays cautious in terms of rate hikes. Since the BOJ ended its negative interest rate policy in March (setting the overnight call rate at zero to 0.10 per cent) to combat inflation, its subsequent dovish stance has supported Japanese markets this year. However, potentially tighter monetary policy, with another rate hike to around 0.25 per cent, and a firmer yen may test equity markets this year. 
• Fixed income opportunities in China, Indonesia and India. Asian high-yield bonds are preferred, relative to investment-grade bonds, on valuation grounds. The recent real estate policies in China are likely to limit further downside, rather than stimulate a major turnaround. Within the China property bond universe, we expect still-surviving developers with quality land banks to benefit more from the headlines. But, defaulted names are unlikely to benefit much from the recent measures. Instead, we favour selected asset management companies within China financials and Indonesian quasi-sovereign bonds. 

Despite recent market volatility on the back of India’s election outcome, where the ruling Bharatiya Janata Party under Prime Minister Narendra Modi lost its outright majority, we believe Indian companies benefit from macroeconomic growth, favourable demographics and structural improvements.

While we currently hold an “overweight” position on Indian fixed income and favour corporate issuers selectively across sectors (including renewable energy and airports), the newly formed government’s policies in relation to key sectors will be closely watched.

The writer is global chief investment officer, Bank of Singapore