Public Equities

Hong Kong-China Equities: A Focus on Structural Opportunities

November 2021 – 2 min read
Supportive policies and the five-year-plan suggest a positive long-term outlook for the Hong Kong-China equity market.

Chinese equities trended lower in the third quarter. Additional regulatory policies were rolled out during the period, which further impacted investor sentiment and led to sell-offs. Moreover, the debt crisis of Chinese property giant Evergrande triggered concerns of spill-over risks, while the power rationing in a number of Chinese provinces—which could cause another shockwave to global supply chains—also weighed on the market. As a result, sectors such as internet, communication services and real estate underperformed the broad market. On the bright side, value cyclical sectors such as energy and materials were relative outperformers over the quarter, underpinned by the imbalance between supply and demand and the surge in material prices as global economies continued to re-open. 

Meanwhile, macro readings have indicated a broad-based slowdown of growth over the past quarter in China, reflecting the impact from COVID waves and new lockdowns, macro policy normalization and near-term tightening of regulatory measures.
 

A Policy-Friendly Environment, But Headwinds Remain

Looking ahead, we expect a more policy-friendly environment from the Chinese government—from supportive monetary policy to additional fiscal spending—in order to stabilize the overall economy. We also expect any forthcoming regulations to be less severe and to come with lower frequency. In our view, the recent focus on regulatory changes in new economy sectors, property and de-carbonization represent the government’s efforts on the development and long-term agenda of economic transformation across China.

At the same time, there are likely to be a number of headwinds to economic growth in the months ahead. For instance, power shortages due to constrained coal supplies will likely continue into year end, which will impact industrial output, especially in power-intensive sectors. Larger companies with facilities located in power-abundant regions stand to face less impact on production. Moreover, supply chain disruptions in parts and shipping may further drive input costs higher. Illiquidity in the property sector is another ongoing issue, but we expect it to be handled in an orderly fashion, given that the Chinese government is well-equipped with tools to prevent excessive spillover risks. Finally, as the global economy emerges from the pandemic, we expect economic activities to gradually normalize through the coming months. Restarting the global economic engine, however, will likely be a bumpy process—and combined with supply chain dislocations, changing central bank policies and geopolitics, near-term volatility in the global equity markets seems to be a given.
 

A Positive Long-Term Outlook

In the absence of earnings results in the coming months, we do not rule out the possibility that Chinese equity markets will continue to be volatile and reactionary to potential negative news flow. However, we believe that periods of volatility can create attractively priced opportunities to build positions in high-quality companies that have returned to reasonable valuations. We also believe the recent regulatory policies, aimed at shaping the Chinese economy for long-term sustainable growth, could lead to new waves of structural opportunities. We are closely analyzing key areas 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 awareness. In our view, this should bolster the outlook for 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 restructuring trends. As income growth continues, the demand for higher-quality goods and services will also increase in China. As a result, we remain constructive on leading domestic consumption companies that have a strong brand and pricing power, as well as companies that are managing to capture market share and benefitting from industry consolidation.

William Fong, CFA

Head of Hong Kong China Equities

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