Investors keen to see whether China’s bull market can keep charging ahead in the lunar Year of the Ox will be focused on the sustainability of economic recovery and the pace of possible monetary tightening.
China’s modern stock markets are only three decades young, but the Year of the Ox (or Bull) has so far managed to live up to its name for investors.
The last lunar Year of the Ox, in 2009-2010, brought a 51 per cent surge in the benchmark Shanghai Composite Index. The cycle before that, in 1997-1998, witnessed a 27 per cent rally.
Of course, past performance is not a reliable indicator of future results. But as the new ox year kicks off on Feb. 12, several factors will be front of mind for investors eyeing China’s markets. First and foremost is that ample liquidity and China’s “first in, first out” recovery from the economic fallout of the global Covid-19 pandemic look set to help sustain bullish market sentiment into the spring, in both the onshore market and Hong Kong. But any flare up in inflationary pressures or sharp turn to monetary tightening could threaten to put a yoke on hard-charging markets.
The recovery continues
Like in 2009, investors today have been emboldened by cheap credit and a strong post-crisis economic rebound. The macro backdrop helps: China’s was the only major economy with positive growth in 2020, and consensus forecasts for this year project GDP rising about 8 per cent. Analysts also expect robust earnings growth for Chinese companies at least in the first two quarters.
In March, China’s legislature, the National People’s Congress, is expected to unveil details of the country’s 14th five-year plan, which will set the high-level growth and development agenda through 2025. This year is also notable as July will mark the 100th anniversary of the establishment of China’s ruling Communist Party, and maintaining social stability and economic strength are paramount goals. Chinese policymakers’ stated aim of achieving a “moderately prosperous society in all respects” means sparing no effort to support growth while minimising systemic risks.
But investors should also be watchful for high volatility and sharp divergence in performance between sectors. In our view, some valuations already look stretched in sectors like technology, consumer and healthcare, where more crowded trades may result in wider price swings. On the other hand, many large financial stocks remain laggards, trading at single-digit earnings multiples or discounts to book value.
Unlike the broad-based bull run in 2009, structural growth themes will likely reign this year, with certain hot sectors and industry leaders dominating the show. Domestic consumption should continue to shine, as Chinese policymakers seek to boost internal demand in the face of ongoing trade tensions with Washington.
Consumers may take the baton from exporters who played a key role in China’s recovery last year. The job market has stabilized with unemployment falling back to pre-pandemic levels, while large savings pots allow the release of more spending power - China has one of the highest savings rates among major economies. Last year, facing the uncertainties of the virus threat, China’s consumers saved even more by cutting back on travel and other discretionary spending, but the rollout of vaccines and continued recovery may allow them to loosen their purse strings once again.
Inflows to Chinese equities have been on a steady rise in recent months, as foreign investors seek exposure to the renminbi’s appreciation as well as China’s economic growth. Investors may also be rotating out of the domestic property market, where the government has imposed tough measures to curb speculation. Recent IPOs of Chinese companies, especially in Hong Kong, have been strong.
Still, there is no way to know how far the 2021 bull can run. We see more cause for caution in sectors where valuation multiples have rapidly ballooned. One key risk is faster-than-expected policy tightening. As the recovery continues and inflationary pressure builds up, China may become the first country to need to mop up liquidity.
So far this year, the People’s Bank of China has been sending out mixed signals, draining funds at times to test market reaction. Concerns over tightening caused market jitters in late January. There may yet be more small tightening steps to cool inflation or limit asset bubbles. Nevertheless, we expect any further normalization of monetary policy to be slow and gradual, as the central bank takes care to maintain market stability in what China hopes will be an otherwise auspicious year.