The Chinese stock market rallied hard after the initial coronavirus crash but doubts over the accuracy of China’s reporting of economic and health statistics, as well as memories of past bubbles in the country, mean some are sceptical on its durability.
On 9 July, domestic Chinese stock indices recorded their biggest one-day gain in more than a year. The Shanghai Composite index closed at 3,450, a two-and-a-half-year high, having risen 16.5 per cent in the space of just eight trading sessions.
The rally left Chinese shares 30 per cent up on their March slump and in positive territory for 2020.
Performance of indices in 2020 (in local currencies)
Source: FE Analytics
Over 2020 so far, the Shanghai Composite index is up 10.16 per cent while the S&P 500 has risen 5.28 per cent and the MSCI AC World gained just 1.64 per cent. These figures are in local currencies.
Chinese state media has been triumphing these as a “healthy bull market”, although Aviva Investors global emerging market equities head Alistair Way and emerging market and Asia Pacific portfolio manager Xiaoyu Liu note this has been met with both optimism and cynicism.
For some, the current situation has brought back memories of 2014 and 2015 when Beijing last urged its population to buy stocks, but the resulting stock bubble burst and left investors wary.
Stretched valuations?
“While the rally in share prices may have gone too far, too fast, as evidenced by the fact the market has fallen back since 9 July,” said Way. “That does not mean Chinese shares are overvalued when compared to international peers.”
Chinese stock valuations do not look excessive
Source: Refinitiv Datastream
At the end of June, the MSCI China Index was trading at a multiple of 15.2 times estimated future earnings. That rich valuation, while impressive, left Chinese equities no more expensive than the emerging market universe as a whole, the Aviva investors pointed out.
Looking at the US, the S&P500 index is trading on a forward price-to-earnings (P/E) ratio of 24.9, which according to both Way and Liu is “a level not seen since the heyday of the dot com bubble”.
However, China and the US have had very different experiences in handling Covid-19. China’s official death toll of less than 5,000 is dwarfed by the US which as of 17 August had reported 170,000 deaths.
While China has a bad reputation when it comes to reporting official numbers, in the two months to 22 July the country reported an average of just 12 new infections per day.
This had the desired effect on sparking an economic recovery and output expanded 3.2 per cent in the second quarter following a record 6.8 per cent slump in the first three months of the year.
“Although the first cases of COVID-19 were in China, it has done a good job of protecting the population and the economy,” said Aviva’s head of emerging market equities.
Questionable statistics?
Like some who have questioned the accuracy of China’s coronavirus statistics, there are some questions hanging over the official numbers on the country’s economic health.
Liu is clear that the truth lies beyond the official statistics and more within encouraging data points from various sectors across the economy. “Even for those who may not want to put too much store in official numbers, unofficial figures on things like electricity usage are painting a similar picture,” she said.
Way outlined that the rally is partially down to Beijing’s efforts to prop up the market, but also through a combination of international institutional investors running underweight positions in Chinese equities.
“My perception is that a lot of funds have been struggling to cut underweight positions and it feels like there’s more to come. It doesn’t look like we’re anywhere near the bubble stage in terms of valuations, certainly nothing like the mania we saw in 2015,” he said.
Technology boom
“There is far more to this story than Chinese retail investors getting overexcited,” added Way.
Despite the tensions between the US and China, and proposals that have made it harder for Chinese companies to list their shares on the US exchanges, US-listed Chinese stocks have performed equally impressively.
While most other emerging equity markets are heavily weighted towards commodities and other cyclicals, the Chinese market is increasingly bolstered by the dominance of giant internet companies.
“From an emerging-market equity investor’s perspective, it’s suffering significantly less earnings pain,” said Liu. “It’s a really good place to be relative to other areas of the universe.”
However, both Liu and Way conceded that the valuations in the technology sector look somewhat extreme.
For example, shares of food home-delivery company Meituan have almost tripled since the IPO in September 2018. The company is valued at $147bn, which gives it a bigger weight in the MSCI Emerging Market index than the entire Indonesian stock market.
“It’s part of the overall growth against value dynamic, with investors of all natures preferring to buy concept stocks, technology stocks, internet stocks, and largely ignoring the rest of the market,” said Way.
Areas of value
With the majority of growth stocks highly priced, Way and Liu outlined that there is value in the travel and tourism industry, which suffered sharp losses earlier in the year.
“Online travel agents that are focused on the domestic economy, such as Trip.com have been among the weakest areas of the market this year,” he said.
“We see upside potential so long as things continue to normalise.”
Liu identified long-term value in insurance stocks, considering Chinese GDP per capita last year rose above $10,000. “This is the level at which people start to feel they have enough money to take out health and life insurance policies for the first time,” she said.