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Futures data is displayed on a stock ticker in Pudong’s Lujiazui Financial District in Shanghai, China, on January 30. Domestic investors are waiting for March, when the annual meetings of the NPC and CPPCC will set the economic and market tone for the coming year. Photo: Bloomberg
Opinion
The View
by John Woods
The View
by John Woods

As Chinese stocks climb despite wall of worry, how long more will onshore investors wait in the wings?

  • Investors have reason to worry about geopolitical risks, China’s economic challenges and tightening global monetary conditions
  • But a positive ‘two sessions’ outcome could finally bring out traditionally cautious onshore mutual funds and retail investors to join the rally
John Woods
John Woods
Why you can trust SCMP

For a market rally to sustain, it must climb a wall of worry every day, surmounting the challenges, fears and negativity put in its way. Painfully and step by step, it is how bull markets typically develop, evolve and push higher – and this is how China’s equity rally has behaved in recent months.

Born out of an expectation last October that Beijing’s detrimental trifecta of zero-Covid, property deleveraging and policy intervention would be remedied, then given hope and oxygen last November by the start of China’s economic reopening, the rally in the MSCI China Index has gained a (halting) traction of sorts. This has resulted in a price appreciation of around 9 per cent for the year to date.
Yet China’s wall of worry is high and pitted with obstacles to trip up the unwary investor. Geopolitical risks could undermine positive investor sentiment at any time.

Meanwhile, the tightening of global monetary conditions and China’s economic challenges complicate an already opaque investment thesis.

Over this year, China’s growth and earnings outlook will comfortably outperform its developed market peers, and this is a main reason the bull market is alive and well. But there is uncertainty as to whether official policy will remain investor-friendly, simmering asset quality issues in the banking sector, and looming solvency risks, albeit in the medium to long term, among local government financing vehicles. Think of it as a yet another brick in China’s great wall of worry.

Still, the mood towards emerging markets generally – and China in particular – is gradually brightening.

A woman poses for photos in Pudong’s Lujiazui financial district in Shanghai on January 30. The outlook in Chinese markets have brightened considerably since the economic reopening. Photo: Bloomberg

In the first five weeks of this year, investors reportedly added over US$2 billion to US-based mutual and exchange-traded funds that buy Chinese equities. China’s Stock Connect programme recorded northbound investment amounting to US$21 billion, its largest single month of inflows since the programme’s inception in 2014.

Six months ago, I was still getting questions from investors as to whether China equities were “uninvestable” and whether the Chinese market was a credible investment destination. Now, apparently, sentiment has swung by a full 180 degrees and investors are fretting instead over whether positions are too “crowded”. In relative terms, this is a nice problem to have.

Compared to their more bullish offshore counterparts, onshore institutional and retail investor appetite for – and confidence towards – risk-taking is limited. The investor community in China is still in a state of semi-shock after the events of the past three years.

More importantly, domestic investors are waiting for March, when the “two sessions” – the annual meetings of the National People’s Congress and the Chinese People’s Political Consultative Conference – will set the economic and market tone for the coming year.

For the economy, China is expected to target a modest growth target of above 5 per cent, with fiscal deficit slightly higher at around 3.1 per cent, and the headline consumer price index at a stable 3 per cent. Further monetary easing is also expected through cuts to banks’ reserve requirement ratios and the policy rate. In other words, expect a reasonably pro-growth economic strategy with measures to ensure credit is channelled to private businesses – all consistent with getting the economy back on its feet.

Pedestrians are reflected in a store window in the Wangfujing shopping area in Beijing on February 10. Chinese policymakers are expected to stick to a reasonably pro-growth economic strategy, with measures to ensure credit is channelled to private businesses. Photo: Bloomberg

The allocation of liquidity to small and medium-sized enterprises (SMEs) is important from a market perspective, as the private sector (mostly SMEs) accounts for well over 60 per cent of China’s gross domestic product.

Additionally, a robust performance by the private sector underpins positive expectations for earnings per share growth of 16 per cent this year. More broadly, as economic and market confidence further improves, a positive feedback loop develops between the provision of liquidity and the performance of equities.

Assuming a positive, business-affirming outcome from the two sessions, onshore confidence towards risk-taking is likely to improve. This would be significant as risk-taking among China’s two largest investor constituencies – mutual funds and retail investors – has been constrained, with both parties yet to fully commit to the market beyond historically average levels of exposure.

For context, China’s asset management business amounts to some 68 trillion yuan (US$10 trillion), with mutual funds accounting for 43 per cent as of the third quarter of last year.

China’s mutual funds are making money again after grim reports in 2022

But until recently, mutual funds were relatively quiet investors. They only started increasing their exposure in mid-January, when the proportion of assets under management allocated to equities increased to 65 per cent from 61 per cent. If this rose to around 68 per cent, returning to levels seen throughout 2019–2022, another US$120 billion of firepower could be put to work.

China’s famed, albeit nervous, retail investors have been similarly quiet and cautious over the past three months despite sitting on record cash deposits, which grew by the equivalent of US$6.3 trillion last year alone.

China’s retail investors rarely cross the road first, preferring that market rallies gain momentum and institutional investors make the initial move. But assuming a reasonably positive two sessions outcome, and traction developing among institutional investors, retail investors will probably become active again.

When house prices are so depressed, the equity market opportunity is just too attractive to ignore.

John Woods is chief investment officer for Asia-Pacific at Credit Suisse

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