For a long time, Beijing avoided lowering the rate for the sake of the stability of the RMB. However, the threat of deflation amid the protracted real estate crisis, rising debt, worsening consumer sentiment and trade barriers provoked by the threat of a "Chinese shock" forced the Central Bank to begin easing of credit terms. What are the prospects for China? And are there any interesting trading ideas in Asia's largest market? Finam.ru studied the situation and the recommendations of professional market participants.
Slogans vs Facts
Xi Jinping has set ambitious economic goals for the Chinese government: modernization of industry, expansion of domestic demand and reduction of risks in the debt and housing sectors. However, neither during the “Two Sessions” nor during the “Third Plenum” did the country's leaders present a detailed plan to achieve these goals. This caused skepticism and disappointment among economists and analysts. By the way, ten years ago, the authorities also promised to eliminate the imbalance between high levels of investment and production and sluggish demand. Since then, the situation has not improved significantly, China's economy remains export-oriented, and the change of course to domestic demand is stalling.
The previous drivers - cheap labor, foreign trade expansion, real estate investments - have stopped moving the Chinese economy. In the TikTok era, people are no longer ready to work in factories for pennies, consumer demand in the United States and Europe is recovering slowly after COVID-19, and the housing sector in China is experiencing a crisis. All this indicates the inevitability of transformation, and Beijing understands this, having been talking from high rostrums about "double circulation" and "new productive forces" for several years, but in fact there are no structural changes.
"There are no clear signals of a change in macroeconomic policy," Zhang Zhiwei, chief economist at Pinpoint Asset Management, reacted to the results of last week's "Third Plenum" - a closed-door session of the Central Committee of the Communist Party under the leadership of President Xi Jinping, which is held approximately once every five years.
"Supply-side policy will continue to prevail," said Tommy Wu, senior economist at Commerzbank AG. Instead, economists would like to see the authorities stimulate consumption, solve the debt problem in the real estate sector and increase infrastructure spending.
The Third Plenum, around which there were so many expectations, provided even more mysteries: no fateful statements were made, according to Chinese tradition, the intrigue was postponed to the Fourth Plenum, which will be held probably in November, comments Gennady Fofanov, president of the investment platform “InvoiceCafe”.
"In general, it is worth starting to realize that the decisions of the Plenum of the Party may no longer be such an important factor of development for China compared to the decisions of Xi Jinping, the concentration of power around whom is becoming more and more noticeable. From what can be deduced from the results of the Third Plenum, it is worth highlighting the tax reform, which will probably consist in increasing the ability of regional authorities to levy additional local taxes. This is clearly not going to help China's economic growth and stock market. As well as Xi's statement about "defending sovereignty and self—reliance development" - in the current conditions, I would interpret this as an ongoing trend towards economic confrontation with the West, which also does not contribute to the growth of quotations of Chinese companies," Fofanov notes.
However, something has been done. The authorities announced a plan to issue extra-long special sovereign bonds worth one trillion RMB ($139 billion) and announced tax reform. But investors are waiting for more decisive measures to support the economy.
The National Bank of China reduces rates
And so, in the third decade of July, China unexpectedly lowered key rates, thus trying to support the "fragile" economy. In the second quarter, GDP grew by only 4.7%, which is below the target 5%. But the Central Bank's first step is still timid - only 10 bp, although this surprised the markets. Now the annual lending rate (Loan Prime Rate, LPR-1) has been revised to 3.35%, and the five-year LPR to 3.85%.
"Although the move is rather cosmetic, the Chinese seem to believe in the Fed's willingness to move to lower rates soon. Although, of course, such a reduction is not enough in principle, given zero inflation – real rates remain extremely high. In a good way, the National Bank of China needs active steps to reduce, the current 10 percentage points in six months do not solve anything," comments Egor Susin, author of the TruEcon Telegram channel.
Lower rates will increase pressure on Chinese banks, says ING Economics analyst Lynn Song, noting that the net interest margin of Chinese commercial banks is already at a record low, and non-performing loans are growing rapidly.
According to Alexey Tretyakov, CEO of Aricapital Management Company, today's rate decision is unlikely to significantly affect the Chinese economy, but it signals a willingness to weaken the RMB.
Devaluation can be quite moderate, about 3-5% from the current level of USD/CNY ~7.30 to 7.5-7.7. In addition to the task of reviving the economy, devaluation could help in the fight against low inflation (annual inflation in June was only 0.2%). A moderate devaluation looks the most likely, but not the inevitable scenario, the expert believes.
Due to cheap loans, Chinese manufacturers will double their capacity and sales, and most of the goods are intended for export. However, on the other side of the Pacific Ocean, they do not want a repeat of the "Chinese shock" that Western countries experienced in the early 2000s. This means that a new round of "trade wars" is ahead.
Is the Chinese market undervalued?
Most economists expect the Chinese economy to slow down in the medium and long term due to structural constraints and the risk of a "middle income trap." Thus, according to the IMF forecast, by 2028 the annual growth rate of China's economy will decrease to 3.4%. At the same time, the Bloomberg Economics forecast suggests that China will continue to increase the share of high-tech sectors, and in 2026 their share will reach 23% of GDP, exceeding the share of the declining real estate sector.
"The rate cut cheered up the market a little, and the Hang Seng index was able to push off from local lows, but this will not change the general picture - the market is still heavily dependent on government support measures and geopolitics. Recently, the chances of Trump winning the presidential election have increased significantly, and the market has been under pressure, as the trade war is likely to intensify under Trump. The general minor mood in stock trading in Asia after Biden's withdrawal from the presidential race also affected - this increased the uncertainty of US policy in the Asia-Pacific countries. Our baseline scenario for the Hang Seng index remains in force – it is a "sideways" in the area of 16,000 -22,000 points. The "bearish" trend from 2021 has been broken, but so far there are no conditions − neither technical nor fundamental − for a sharp comparable upward growth, therefore, a departure to the "flat" is likely. The growth of geopolitical risks, heterogeneous macro data, as well as the intensification of the trade war with the United States prevent the mass arrival of Western investors for a long time, and market multipliers will remain underestimated because of this," comments Natalia Malykh, head of the stock analysis department at Finam.
For risk-tolerant investors, the analyst recommends taking a closer look at the shares of China Oilfield Services, HKEX, NetEase and ENN Holdings.
"China Oilfield Services is an oilfield services company specializing in projects related to offshore oil production in China. More than 80% of the company's revenue is accounted for by the parent oil company CNOOC, which plans to increase production by 16-19% by 2026 relative to the level of 2023. Against this background, China Oilfield Services is increasing revenue and EBITDA at double-digit rates, paying dividends with a yield of about 4.1%, gradually reducing debt and has a modest estimate of 6.7 EV/EBITDA 2024E. Our target price for China Oilfield Services shares is HKD 9.07, the upside is 32%," Malykh believes.
Finam analysts expect that monetary and fiscal stimulus measures by the Chinese authorities will support the economy and lead to a gradual increase in global investors' interest in Chinese stocks, which look relatively inexpensive in multiples compared to other markets. And Hong Kong Exchanges and Clearing (HKEX), which allows foreigners to make transactions with shares of Chinese companies traded both in Hong Kong and on the exchanges of mainland China, will benefit from this. We also note the fairly high dividend yield of HKEX shares (3.3% NTM) in comparison with other leading exchange operators in the world.
“Over the past year, NetEase (9999.HK) shares have had a similar performance to the Hang Seng Index. The company continues to show positive results, especially revenue growth and profitability better than analysts' expectations, which provides some support to the quotes. Therefore, with the continued growth of the Chinese market, including against the background of incentives from the authorities, NetEase shares may be among the growth leaders," comments Natalia Malykh.
Shares of Chinese ENN Holdings, specializing in the distribution and marketing of natural gas, according to analysts of Finam, may grow by 34%. The key driver will be the recovery of gas demand in China: according to the latest IEA report, natural gas consumption in China increased by 11% YoY in the 1st quarter of 2024 and may exceed record levels in 2021 by the end of 2024. A positive factor is also the higher-than-expected growth in industrial production in July (+5.3% YoY). Last year, ENN Holdings showed relatively weak results, mostly due to sluggish demand from industrial customers," Malykh believes.
InvoiceCafe recommends keeping an eye on the rhetoric of Chinese and U.S. leaders when making decisions about investing in Chinese companies.
"The Chinese stock market in the form of the CSI 300 index, which includes stocks from the Shanghai and Shenzhen stock exchanges, decreased by 2.1% in the second quarter of 2024. China's GDP in the second quarter grew by 4.7% YoY in real terms, which is small for its economic model, and this means that neither the consumer sector nor industrial production does not provide the necessary momentum in terms of power. Investors can be recommended to observe the decline in indicators for another 1-2 quarters, and if there is no aggravation of the political situation around China, only then begin to consider the possibility of buying shares of individual companies, such as, for example, the manufacturer of electric cars BYD, and then as a very small share in the portfolio," recommends Gennady Fofanov.
