Stay constructive on select China sectors

Stay constructive and selective on industry leaders in the technology and new retail sector
Chief Investment Office24 Aug 2021
Photo credit: AFP Photo

Stay constructive on select China sectors

A series of new policy announcements by the Chinese government negatively impacted market sentiment and drove Mainland China indices to recent lows. MSCI China’s market capitalisation shed USD2.3t to USD11.2t for the week ended 20 August, from the recent peak of USD13.5t in mid-February this year.

The selling widened to non-technology sectors as investors evaluated the new policy announcements. For example, the government introduced policy initiatives to address a wider range of social economic aspects in an effort to balance prosperity and equality.

Even though these measures may impact the near-term profit growth of companies, we do not expect their long-term growth potential to be derailed.

Government regulatory changes and external headwinds are not new. For example, in Figure 1, there have been previous measures pertaining to stock market policy tightening and short selling (point 1), and the trade war from the US (point 2). In each of these instances, the market recovered subsequently. We believe the recent policy announcements (point 3) would not affect the long-term investment outlook.

Figure 1: China equities going through policy changes

Source: Bloomberg, DBS

The recent 30% market correction has been significantly larger than the 10% downgrade in earnings forecast. As a result, we believe much of the policy impact has already been factored in. As these polices are not broad-based, and are geared more towards specific sub-sectors and individual companies, we expect equity prices to soon stabilise.

Figure 2: China equities corrected on recent policy tightening

Source: Bloomberg, DBS

There is also support for sectors that have a pivotal role in advocating the country’s structural shift towards more sustainable and balanced growth.

The policy directions aim to shape a sturdy foundation for the world’s most populous and second largest economy. As the country embarks on a journey to make complicated gadgets and components, and expand the services sectors, the backing of capital markets will be essential. A credible and solid national policy framework to address comprehensive national interests will improve the social-economic structure and forge new growth areas going forward.

Valuations approaching reasonable levels. The recent selloff has led to valuations in terms of price-to-book (P/B) (Figure 3) and forward price-to-earnings (P/E) (Figure 4) to be closer to their historical means, and thus, are no longer overvalued.

Figure 3: China equities P/B ratio

Source: Bloomberg, DBS

Figure 4:
China equities forward P/E ratio

Source: Bloomberg, DBS

Investment Positioning. China’s journey to technology advancement and higher self-sufficiency remains intact. The beneficiaries include the development of AI, big data, industrial robotics, integrated chips, and wafer manufacturing.

We maintain our stance to stay constructive and selective on industry leaders in the technology and new retail sector, and in the sectors of insurance and large banks which have the capacity to distribute attractive dividends.

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