China Economic and Market Outlook 2023

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For the past two years, the Chinese economy and stock market have faced a slew of troubles at home and abroad. Overseas challenges include global rate hikes aimed at curbing inflation, sanctions against China on the semiconductor front, tightened auditing requirements on Chinese ADRs and the risk of foreign investment fleeing China. Domestically, the impact of COVID lockdowns as well as the regulatory crackdown on the property sector, platform companies and after-school tutoring services also burdened the economy. In this article, we summarize the latest developments on these trends as we enter a new year.

The End of Global Rate Hikes?

Rate hikes by central banks are slowly coming to an end. Inflation in the US consists of three main categories: goods, housing and services. To begin with, inflation of goods has been improving, coming down around one-third from the mid-to-high levels in 2022 as oil prices decline amid the ongoing economic slowdown. Transpacific container freight rates have dropped by approximately 80% from the higher levels. Food prices may be approaching a peak as well. For the housing category, the Case-Shiller Home Price index, which usually leads the rent price index by 14 months or so, has peaked and is now in decline, which means the peak in rent prices may be just around the corner. As for services inflation, which tends to be stickier, price increase seems likely to continue for the time being. Fortunately, with goods inflation easing outpacing services inflation rising, the overall inflation is slowing down. However, the Fed is only expected to consider lowering interest rates after services inflation peaks. Interest-rate futures currently point to a peak of 4.9% in the federal funds rate around mid-2023, but there may only be room for lower rates towards the end of 2023.

Improving Conditions for Domestic Capital Flows?

Capital flows in China are showing signs of improvement. As of the end of November, the nation’s broad M2 money supply balance was 264.7 trillion yuan, representing a year-on-year growth of 12.4% and faster growth compared to the previous month. People’s Bank of China (PBOC) Governor Yi Gang also stated recently that, in 2023, the central bank will focus on keeping the growth of M2 and total social financing (TSF) in line with nominal economic growth. It is worth noting that, in early December 2022, the PBOC directly purchased bonds issued by the Ministry of Finance, which could potentially be seen as a move to test out modern monetary theory (MMT). During the pandemic, the US administered a light dose of MMT policy, which led to a bull market and the inflation that followed. MMT is a double-edged sword. It helps boost the economy but comes with a clear side effect of inflation. The US only chose to use MMT out of the concern that quantitative easing alone would not be enough to fight the pandemic. Interest rates in China are still far above zero, and so far the country hasn’t resorted to QE. On top of that, since domestic banks are under government control, it is unlikely that bank lending will dry up with government backing. Meanwhile, how MMT may work out is something that merits further observation.

Has the Dollar Peaked?

Historically, a weak dollar can stimulate global capital flows, supporting the economy and stock market in emerging markets. Over the past one year and a half, the US economy has been relatively strong. This, coupled with interest rate hikes that began early on, has resulted in a strengthened dollar. As the US rate-hike cycle seems to be nearing its end, its boost to the dollar is starting to ease, which should help facilitate global capital flows. Of course, many factors can affect exchange rates. The interest rate is only one of them. For the time being, the US economy outlook is still brighter than most developed countries. A dollar bear market like the one that lasted from 2002 to 2008 does not look likely at the moment.

Are We Seeing the Worst of Tech Sanctions against China?

Not just yet. The U.S. is working with other countries to further undermine China’s efforts to develop its semiconductor industry. Dutch company ASML enjoys a monopoly position in manufacturing cutting-edge lithography machines. Japan plays a key role in supplying high-purity chemicals used in the semiconductor production process. The U.S. controls advanced chip design software. And Taiwan’s TSMC dominates advanced chip manufacturing. These four fortresses will remain hard to conquer for the time being. However, there are sectors where China is in the leading position or at least neck and neck with other countries. Such sectors include electric vehicles (EVs), EV batteries and photovoltaic (PV) panels. The automotive industry accounts for 12% of Japan’s GDP, which indicates the industry’s importance to the country’s economy. But currently Japan seems to be falling behind in the EV race. Building a strong EV industry requires battery technology and software design capabilities, both of which China already possesses. If China can seize the opportunity and leverage the size of its economy to accelerate and scale its EV industry, it has a great chance to replace Japan as an EV powerhouse, which will be crucial in driving China’s economic growth in the future. A key risk ahead would be how U.S. sanctions against China’s semiconductor industry could affect the development of the country’s EV industry.

Is Delisting Risk for Chinese ADRs subsiding?

Things are looking up. China has recently granted U.S. regulators full access to inspect audit working papers of US-listed Chinese firms, which helped ease delisting threats over US-listed Chinese companies for the short term.

Have Domestic Policies Taken Turns?

China has relaxed its strict COVID restrictions. The policy change will facilitate a return to normal life and revive economic activities. Industrial manufacturing and consumption are expected to pick up soon, and a strong economic recovery should follow consequently.

Apart from that, real estate policies and internet platform regulations are also seeing welcoming improvement.

In late November 2022, the Chinese authorities launched a 16-point plan to provide financial support for the property sector. Measures include granting loan extensions to property developers and encouraging financial institutions to provide developers with more support over mergers and acquisitions. As these measures address critical challenges faced by developers, liquidity difficulties in the real estate sector may see further improvement. The principle that “houses are for living in, not speculation” will remain as the main policy direction, but it’s safe to say that the worst is behind us. And since most banks are state-owned in China, systemic risks are unlikely to arise. The gradual release of liquidity into the real estate market should alleviate public concerns and bolster consumer confidence and market demand, which is conducive to the Chinese economy as a whole. In addition, the country’s stance towards big tech firms is beginning to change, as evident in the authorities’ latest approval of imported video games, adding another positive factor for economic recovery in 2023.

Is Foreign Capital Fleeing China?

The numbers haven’t shown any signs of capital flight from China. Although there have been reports saying foreign capital is fleeing, China’s current balance of payments does not reveal any signs of this trend. Foreign direct investment (FDI) in 2021 hit the third-highest in the history. The first half of 2022 also saw a quite FDI inflow. China’s industrial sector might be evolving beyond assembly lines that require less capital investment but generate little added value, and expanding into factories that require greater investment in equipment but could bring medium-to-high added value. While installing assembly lines only takes a few months, the business challenge lies in managing tens of thousands of workers on the assembly lines. On the other hand, investing significant capital in industrial equipment usually requires long-term planning. For instance, the investment horizon for a chemical plant can be many years ahead. In other words, the FDI numbers we’re seeing now in China’s balance of payments can be the materialization of investment plans years ago. Where foreign investment may go from here is something for investors to keep an eye on.

Overall, most factors affecting the Chinese stock market are improving. The chances are growing that China’s stock market is heading down a promising path in 2023.

Disclaimer

This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.

Investments involve risks. Past performance is not indicative of future performance. You may lose part or all of your investment. You should not make an investment decision solely based on this information. Each Fund may have different underlying investments and be exposed to a number of different risk, prior to investing, please read the offering documents of the respective funds for details, including risk factors. If you have any queries, please contact your financial advisor and seek professional advice. This material is issued by Zeal Asset Management Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong.

There can be no assurance that any estimates of future performance of any industry, security or security class discussed in this presentation can be achieved. The portfolio may or may not have current investments in the industry, security or security class discussed. Any reference or inference to a specific industry or company listed herein does not constitute a recommendation to buy, sell, or hold securities of such industry or company. Please be advised that any estimates of future performance of any industry, security or security class discussed are subject to change at any time and are current as of the date of this presentation only. Targets are objectives only and should not be construed as providing any assurance or guarantee as to the results that may be realized in the future from investments in any industry, asset or asset class described herein.

Revisiting e-commerce platforms

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An investing quote goes: When the last bullish investor turns bearish, it’s only a matter of time before the market bottoms out. Masayoshi Son, Softbank’s chief executive officer and a staunch supporter of Chinese e-commerce stocks, recently reduced the company’s holdings of Alibaba stocks from 23.7% to 14.6% – could Son be that last bullish investor? All jokes aside, Softbank does have to raise cash to pay off some of its loans, and now could be a good time to review how investors should approach the businesses of e-commerce platforms.

Increasingly fierce competition

Investors who have looked closely at Alibaba’s results over the past few fiscal quarters must have noticed what management attributed to having impacted its earnings: Intensifying competition. Though of course, most investors know full well that the tightening regulatory oversight should also be among the factors that have had a bearing on Alibaba’s results. But its management, with Alibaba being at the forefront of regulatory actions, clearly knows better than to speak in public about anything related to the government. Indeed, the domestic e-commerce space has seen competition flare up significantly over the past few years. Pinduoduo, for example, now boasts active users whose number rivals that of Alibaba, while its gross merchandise value jumped 16-fold in the previous four years, up from just 3% to 30% of the gross merchandise value of Alibaba’s China commerce at the end of last year. Given that each active user spends around CNY 2800 annually on the Pinduoduo platform, just a fraction of the CNY 8800 annual spending of Alibaba’s active users, there should be plenty of scope for Pinduoduo to grow. While the company has repeatedly emphasised in the past that the platform focuses on agricultural products, as long as it garners enough users, it should be able to expand into other product categories with relative ease.

Apart from Pinduoduo, some short video platforms are also accelerating their livestream shopping businesses. Despite the Chinese government’s ongoing attempts to tighten regulatory control since late last year over the livestream shopping industry, Kuaishou still managed to grow its gross merchandise value by 47% in the March quarter compared with the same period the previous year. And in the last 12 months until the end of the March quarter, its gross merchandise value reached CNY 730 billion, close to 9% of what Alibaba made. While there’s no official data on TikTok, given that it’s still a private company, surely TikTok would boast more livestream transactions than Kuaishou. Clearly, competition among e-commerce platforms looks set to get increasingly fierce.

Earnings outlook

There are many one-time charges in Alibaba’s financial statements that if one is to get a good grasp of its earnings trends, one will have to look not only at its annual report, but also keep track of its core earnings per share in each fiscal quarter with all one-time charges removed from the analysis. Alibaba’s year-on-year core earnings per share started to drop since fiscal third quarter last year, and continued into fiscal second quarter this year without showing signs of narrowing in the scale of the decline. Given a slowdown in China’s economy induced by Covid-related lockdowns beginning in March, it remains unclear where the bottom of Alibaba’s earnings lies. As such, the pace at which Alibaba’s year-on-year earnings grow in fiscal second quarter becomes even more important – even though a low base last year would mean that the company should be able to achieve a year-on-year increase in earnings relatively easily, investors will need to be mindful of the residual effect of Covid-related lockdowns on Alibaba. And despite a plethora of investment initiatives, there’s no denying that, thus far, Alibaba generates a large part of its profits from the traditional retail e-commerce business in the domestic market. Unless any of its businesses make a breakthrough, we think it’s unlikely that Alibaba will see its earnings grow at the same scale as before.

The valuation of Alibaba

Alibaba has seen a decline in its year-on-year earnings since fiscal third quarter last year. Assuming a full-year drop in its core earnings in fiscal third quarter this year, and taking that into account in the calculation of its price-to-earnings ratio (P/E ratio), it will place Alibaba’s current P/E ratio at around 13.3x. Unless its earnings fall further on a year-on-year basis, we believe this P/E ratio looks quite fair.

Last but not least, given Alibaba’s plan to make Hong Kong its primary listing destination, capital from mainland China will likely stream across the border into Alibaba at the end of the year, supporting its stock price. 

Conclusion

To summarise our analysis of Alibaba above, as the domestic e-commerce industry grows ever more competitive, we don’t see any new growth area for the time being unless there is a breakthrough in Alibaba’s new businesses. But if its earnings stabilises on a year-on-year basis in the coming fiscal quarter, there should be limited room for the stock price to retreat further from its P/E valuation of 13x. Meanwhile, it should help that Alibaba is seeking a primary listing in Hong Kong, whose capital inflow from China will likely support its share price.

Disclaimer

This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.

Investments involve risks. Past performance is not indicative of future performance. You may lose part or all of your investment. You should not make an investment decision solely based on this information. Each Fund may have different underlying investments and be exposed to a number of different risk, prior to investing, please read the offering documents of the respective funds for details, including risk factors. If you have any queries, please contact your financial advisor and seek professional advice. This material is issued by Zeal Asset Management Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong.

There can be no assurance that any estimates of future performance of any industry, security or security class discussed in this presentation can be achieved. The portfolio may or may not have current investments in the industry, security or security class discussed. Any reference or inference to a specific industry or company listed herein does not constitute a recommendation to buy, sell, or hold securities of such industry or company. Please be advised that any estimates of future performance of any industry, security or security class discussed are subject to change at any time and are current as of the date of this presentation only. Targets are objectives only and should not be construed as providing any assurance or guarantee as to the results that may be realized in the future from investments in any industry, asset or asset class described herein.