Is the Chinese Market Finally Bottoming Out?

Posted on

The Chinese stock market has been hovering at low levels for a long time, with the performance of Hong Kong stocks particularly dismal. The Hang Seng Index fell by 12% in 2021, followed by declines of 13% and 10% in 2022 and 2023, respectively. The bear market in 2021 and 2022 was somewhat expected, but last year, with the economy reopening at the start of the year, investors were generally optimistic. However, the market continued to fall. Whenever positive news seemed to emerge, signalling a turning point, it was followed by another wave of declines, each lower than the last.

At its core, stock investment is a matter of confidence. The main culprit behind the dismal performance of the Chinese market is the lack of investor confidence. Therefore, good news is often ignored, no news is interpreted as bad news, and bad news triggers indiscriminate selling.

Without an increase in confidence, the stock market will struggle to see a meaningful rebound. Fortunately, signs of a bottoming out of confidence seem to have emerged.

Firstly, with concerns about earnings dissipating, market sentiment has significantly improved.

Major earnings estimate downgrade was one of the main causes for the sluggish performance of Chinese stocks last year. The initial enthusiasm surrounding the reopening in early 2023 led to ambitious growth expectations for companies. However, weak economic recovery and subdued demand after the second quarter undermined companies’ profitability, as they had to constantly adjust their business strategies, significantly increasing the difficulty of inventory management and cost control.

Despite initial consensus estimates of mid-teens earnings growth for the MSCI China Index in 2023, this figure was slashed to mid-to-high-single digit by year-end. In fact, the actual growth was even lower than the revised estimate. Yet, as investors had already factored in the worst-case scenario, the realization of tepid results didn’t exacerbate market sentiment. Instead, attention shifted towards prospects of a 2024 economic recovery after the result season.

While aggregated demand may remain weak this year, visibility in the macroeconomic environment has improved compared to 2023, allowing companies to set relatively realistic sales targets in a more certain economic environment, which generally bodes well for earnings growth.

Secondly, recent improvements in some economic data boosted the confidence of many overseas institutions, prompting them to upgrade their forecasts for China’s growth this year. Goldman Sachs raised its 2024 GDP forecast from 4.8% to 5%, while Morgan Stanley also revised up its figure from 4.2% to 4.8%.

In fact, not all economic data were showing improvement, but GDP and consumption indicators significantly exceeded expectations. GDP grew by 5.3% year-on-year in the first quarter. While the real estate sector continued to lag, exports demonstrated strong resilience. Consumer potential is also gradually being unleashed, with 1.19 billion trips taken during this year’s Qingming Festival holiday. More importantly, the average spending per trip increased compared to 2019 levels, marking the first time this data has surpassed pre-pandemic levels since the economic reopening. Considering that short trips have become more popular now, the increase in average spending further indicates an increase in household consumption willingness.

Thirdly, foreign investors are beginning to reconsider China. Due to factors such as the pandemic lockdown, the real estate crisis, and the regulatory crackdown on platform companies, foreign capital has been flowing out of China in recent years. In 2023, while emerging markets overall saw inflows of foreign investment, $82.2 billion worth of Chinese stocks and bonds were sold. However, there are signs of a recent reshaping of foreign investor confidence. We have witnessed a significant increase in the number of foreign investors at recent investment summits. Additionally, last year, when faced with relatively positive company earnings guidance, their initial reaction was skepticism. While it cannot be said that they are fully embracing it now, it is clear that they are searching for reasons to reallocate to China. This change is attributed to extremely low valuations, but also to increased confidence resulting from the improving economic data. Over the past month, the level of buying from our institutional clients has reached a level not seen in the past year. From this perspective, market sentiment seems to be changing.

Overall, the Chinese stock market has experienced too many instances in the past two years where it seemed like dawn was approaching, only to fall back into darkness. Whether this time it will truly recover remains to be seen, and subsequent economic data and external risks need to be closely monitored. However, the momentum of change appears to be approaching a pivotal point.

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.

In respect of any discrepancy between the English and Chinese version, the English version shall prevail.

Opportunities and Challenges in China’s Exports

Posted on

If investors were to visit the Xiaomo International Logistics Port in Shenzhen, they might have the chance to see a particularly unique giant ship moored at the port. Measuring about 200 meters in length, this ship, unlike regular container cargo ships with open cargo holds, has a sealed hull, resembling a white sardine can. This is the first ship built by the Chinese automotive brand BYD for its overseas fleet, named Explorer No.1, capable of carrying 7,000 vehicles. On January 15th, Explorer No.1 set sail from Shenzhen, carrying 5,449 new energy vehicles destined for the Netherlands and Germany.

Ports are one of the best places to observe a country’s export trends. In the past two years, major Chinese ports such as Shanghai, Ningbo, Shenzhen, and Qingdao have seen a booming development in the export of Chinese electric vehicles (EVs). In addition to EVs, other products related to new energy have also accelerated their pace of going global, among which EVs, solar cells, and lithium batteries lead the growth. These are even given the code name “new three” by the authorities, corresponding to China’s previous export pillars of “old three “: clothing, household appliances, and furniture.

In 2023, China’s overall exports were relatively weak, but exports of the “new three” steadily increased, with the export value of these three items reaching about 1.06 trillion yuan, an increase of about 30% year-on-year. Not only is the proportion of the “new three” in China’s exports increasing, but their global market share is also significantly rising. Data shows that China now accounts for over 80% of global solar cell exports, over 50% of lithium battery exports, and over 20% of EV exports.

Ordinary people may not be deeply aware of solar cells and lithium batteries, as they mostly belong to the intermediate links of industrial production. However, the rapid development of Chinese EVs is believed to be visible to most investors.

As the second-largest consumer product after housing, decisions to purchase automobiles are usually made after careful research and comparison. Chinese EVs have not only penetrated markets in Southeast Asian countries such as Thailand and the Philippines but also witnessed thriving sales in traditional automobile manufacturing countries in Europe such as Belgium, the UK, and Spain. Statistics show that in the first half of 2023, about 350,000 new energy vehicles were exported to Europe, accounting for about a quarter of the sales volume of EVs and plug-in hybrid EVs during this period. Winning recognition in the European market also demonstrates the attractiveness of Chinese EVs in terms of performance and price.

Challenges Behind the Strong Performance of the “New Three”

Investors focusing on the Chinese stock market may be aware that despite the impressive export data of the “new three” last year, the performance of new energy stocks has been disappointing. On one hand, the market’s tolerance for high-growth companies has significantly decreased due to rising interest rates and a withdrawal of liquidity. On the other hand, excessive internal competition within the new energy sector has also harmed the interests of companies within the sector.

In recent years, strong support and massive subsidies from national policies for renewable energy have led to rapid growth in the industry. However, this has also brought about disorderly expansion and excessive competition.

Since 2022, competition in the Chinese EV market has become increasingly fierce. In order to achieve ambitious sales targets, China’s EV manufacturers have had to reduce prices to capture market share. Therefore, behind the impressive sales figures, many car manufacturers have experienced declining profit margins.

Competition in the lithium battery industry is also fierce. Due to oversupply, lithium carbonate prices plummeted last year. The average price of lithium per ton in the fourth quarter of 2022 was still around 550,000 yuan. But by April 2023, lithium prices had plummeted to around 180,000 yuan.

In addition to intense domestic competition, exports of new energy also face trade restrictions from the US and Europe. In September last year, the EU initiated an investigation mainly because it believed that cheap Chinese EVs were flooding the European market, posing a threat to the local EV industry. The US also indirectly excluded Chinese EVs by passing extremely exclusionary provisions on EV subsidies in the Inflation Reduction Act (IRA). The Biden administration initially imposed a 25% tariff on Chinese solar products. On top of that, sanctions against Chinese solar companies were repeatedly launched, with punitive tariffs of up to 254% on some Chinese solar cell exports.

Irreplaceable Advantages

In response to the intense domestic competitive landscape, new energy enterprises are also exploring various avenues and strategies. In addition to expanding overseas markets and increasing export efforts, companies are also venturing abroad. For example, BYD established a factory in Hungary last year, and its factories in Thailand and Brazil are expected to start production this year. By exploring different developments, companies try to take greater initiative in fiercely competitive markets.

Given the various challenges facing the new energy industry, whether the “new three” can maintain a leading edge in the international market is also a focus of attention. We believe that the advantage of Chinese enterprises comes not only from the vast domestic market that promotes economies of scale (while also bringing fierce competition) but also from the continuous innovation and well-established supply chain. The average education level of newly added labor force in China has increased to 14 years, with a population of 240 million having received higher education. In 2018, China’s per capita GDP was $9,771, but its innovation index score has approached that of European countries with a per capita GDP of around $50,000. Southeast Asian countries are unable to compete with China in terms of innovation and technology in the short term. Although European and American countries have begun to bring back some supply chains after the pandemic, the completeness and flexibility of their supply chains are also difficult to compete with China.

Therefore, while the “new three” face challenges, a great part of those challenges come from internal competition. On the international competitive level, Chinese new energy enterprises still have irreplaceable advantages.

Many new energy enterprises are experiencing the process of “big fish eats small fish,” where small businesses gradually exit the market, and winning companies gain a larger market share. Before the visibility of industry differentiation becomes higher, we will remain a cautious stance towards companies in over-competitive industries. We emphasize a careful balance between growth potential and the risk of declining margins due to heightened competition.

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.

In respect of any discrepancy between the English and Chinese version, the English version shall prevail.