Hong Kong-China Equities: A Long-term Opportunity Amid Volatility
Chinese equities rebounded in the second quarter, led by double-digit gains in the health care sector, after experiencing a correction in the first. However, overall market performance remained soft, partly due to evolving sector-specific regulations. Specifically, heighted policy scrutiny of Chinese super-app Meituan suppressed the internet sector, while the real estate sector faced continued regulatory control to prevent speculation. Frequent style rotations also emerged during the period—growth stocks outperformed in April and June, while value stocks drove returns in May. Toward the end of the quarter, sentiment turned positive ahead of the 100th anniversary of the Chinese Communist Party.
Positive Earnings Growth Expected
The current market environment is less challenging relative to earlier in the year, as many negative catalysts have already materialized and, to some extent, have been priced in by investors. Valuations, for instance, appear to be less stretched and continue to look attractive compared to many key global markets. While volatility is likely to continue in the near-term, and corporate earnings could be affected by increasing raw material costs and new regulations in certain sectors, we expect Chinese equities to deliver positive returns for the rest of this year, primarily driven by solid company earnings.
Specifically, the Chinese economy remains on a steady trajectory of recovery. Chinese goods exports are performing well, with better-than-expected growth momentum as more economies reopen and global demand recovers—and this, alongside normalized but still-supportive macro policy, should help bring about earnings growth for a number of Chinese companies. As a result, we expect to see solid earnings growth from several companies this year.
At the same time, it is clear that the Chinese government is currently aiming for an orderly transition toward the post-COVID era—which involves delicate control between easing and tightening macro and industry policies to contain growth to a reasonable and sustainable level. In particular, monetary policy is likely to be neutral or even supportive to facilitate the gradual recovery of the economy, while fiscal policy will focus on the structural transition and sustainable development of new economy sectors. Concurrently, uncertainty around industry regulation, particularly of tech firms, and U.S.-China tensions on topics ranging from IPOs to national security, have been largely discounted by the market—however, they could present headwinds in the near term.
We expect long-term policy support—which aims to develop structural growth in certain areas—to remain promising, especially those policies illustrated in the 14th five-year plan, such as the continuation of economic transformation toward sustainable growth, self-sufficiency in the supply chain, scientific and technological innovations, and green ecology awareness. Going forward, these policies should provide continued support to sectors and themes such as new infrastructure, domestic consumption, health care, technology localization and sustainability.
We remain constructive on Chinese equities in the medium to longer term. In particular, we continue to find opportunities in quality companies that are well-positioned to benefit from ongoing structural reforms, technology innovations and consumption upgrade trends. As income growth continues, the demand for higher-quality goods and services will also increase in China. As a result, we believe leading domestic consumption businesses that have a strong brand and pricing power, as well as companies that are capturing market share and benefitting from industry consolidation, are well positioned going forward.