China Cheap Again?

• Markets rallied after intense selling pressures and deep pessimism earlier this month. Last week’s gains were seen most sharply in Emerging Markets.

• Chinese shares have fallen hard in the last 13 months, returning the country’s stock market in value-play territory.

• Stimulus measures during this important political year in China could be on the way, which would buoy its onshore and offshore stock prices

Global stocks capped off their best week since November 2020 with gains on Friday. The MSCI All Country World Index was up nearly 5% as investors came to grips with higher interest rates and still elevated commodity prices. The Fed’s meeting on Wednesday was a formality more than anything, but Chair Powell attempted to give a hawkish tone with respect to future interest rate policy. The market believes him for now, as indicated by a jump in Fed Funds futures looking out through 2023.

Volatility

It was a topsy-turvy week for just about all markets. Volatility was seen most starkly in China – just take a look at the Nasdaq Golden Dragon China Index which saw its implied volatility catapult above 100%.

A Bounce-Back Week

Trillion-dollar swings took place in Shanghai as left-for-dead equities suddenly came back to life mid-week. The daily changes were astounding. Alibaba, the largest stock in the iShares China Large-Cap ETF (FXI), vaulted 37% on Wednesday. The surge helped emerging markets experience its best session since the GFC. It comes as foreigner net selling reached its biggest amount since Q3 2020.

For the week, EM was up more than 6% while China shares climbed 14%. The massive move led us to review where China shares stand. Could the region, deemed uninvestable by some, be a value spot? We think so.

Is China a Buy Right Now?

Our flagship Weekly Macro Themes report details the case for owning the China equity market. We see favorable technicals, attractive valuations, and the potential for macro catalysts including stimulus measures.

Taking a step back, last week’s price-action was a blip on the long-term chart. China A Shares and the MSCI China Index remain decisively in bear market territory. Recent moves feature hallmarks of outright crash mode. Covid lockdowns, growth concerns, property market stress, government clampdowns on tech, geopolitics... can we add anything on top of this litany of risks? Is it possible?

Some investors are now contemplating if what happened in Russia could take place with China stocks, or certainly at least reconsidering the role of country/governance risk.

Valuations

Clearly, the mood is pessimistic. We find, though, that valuations are back to the low end of the historical range among Chinese equity indexes. Our featured chart illustrates how absolute valuations look rather good. The relative forward PE vs the MSCI EM Index also suggests China shares are a smidgen cheap

Featured Chart: China Equity Valuations on the Inexpensive Side

Bearish Risks Are Out There

You might counter our contention with the fact that these valuation resets have been commonplace during the nearly 15-year bear market in China – subsequent rallies were short-lived. Moreover, the property market continues to be soft, and earnings growth looks set to roll over amid macro headwinds. The bearish case is indeed something to consider, we concede.

Election Year – Stimulus on the Table

Here’s the upshot for the bulls: China officials have dry powder for stimulus. Xi Jinping is expected to be confirmed to his third five-year term later this year. Stability is a keyword for the current regime. Additionally, monetary and fiscal policies are tight right now, so efforts can be taken to stabilize the economy and stock market.

Subscribers will find more analysis on how to interpret China's leading indicators and the all-important China Credit Impulse data in our latest report.

Bottom Line: China shares are now a value-play territory, with a sharp reset in valuations back to the lower end of their range. That said, a catalyst is required, and likely comes in the form of stepped-up stimulus.

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