China’s equity market has performed poorly for quite some time. It is a big chunk of the EEM index, and as such, has weighed on the vehicles’ returns, but not as much as you might think, given India’s (another large weighting) stellar run.
The proximate cause has been China’s embattled property development sector, where fears of a burgeoning bubble (and indeed there is one) led to a crackdown on credit, namely the three “hard lines” of gearing, relating to liquidity, net debt, and servicing metrics.
Evergrande has been the highest profile casualty of the crackdown, where a lack of rollover financing means projects can’t complete and half completed projects are worth nothing to no-one, which means that builders presently building your projects fear they won’t get paid either, and down tools in the now, and as such the whole thing collapses.
The end result has been carnage for the China proportion of the high yield USD denominated market.
And more spectacularly so for China’s residential exposures.
However, fearing an unorderly unwind, and credit contagion into other, unaffected sectors, China’s authorities have relaxed some of these “hard line” requirements, allowing M&A as an acceptable reason to breach the threshold, such that healthier, stronger balance sheets might absorb the assets of the weaker players, stabilise the sector, and prevent a run on apartments from taking the sector with it.
These measures have been greeted with a stabilisation in yields, as a partial indicator of their success.
The other key reason for underperformance has related to state intervention into private markets, with the authorities declaring what sectors could extract a profit (e.g. banning portions of for-profit education) and how exclusively / how much (e.g. Tencent, Alibaba) as a function of market power.
Relatedly, minimum wage and working conditions were imposed (Meituan, Didi), and the combination of these measured greatly impacted valuations across many of China’s largest companies.
Putting both events together, and perhaps adding a COVID-related overlay, we see a market that is quite cheap by international comparison.
Noting that earnings growth has been quite comparable to other countries.
Gearing overall continues to be a problem, but the size of China’s foreign reserves (~+$3tn USD) does mean that China is unlikely to be vulnerable to the “sudden stop” balance of payments type crisis that can make emerging market equities so risky.
Likewise, the acceptance of lower growth targets going forwards, as a means of shifting income away from traditional drivers of growth (fixed asset investment and property development) and towards domestic consumption (household share of GDP, household expenditure, retail sales) could auger well for China’s fortunes, with a healthier balance of GDP and less “bezzle”, as China commentator Michael Pettis would put it.
If China’s regulatory interventions are behind it (having achieved their desired effects) and the property market stabilised (relatively speaking) valuations could well be quite attractive, in the current market.
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