(Bloomberg) — Chinese stocks may have bottomed, but money managers are reluctant to return en masse.
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The MSCI China Index’s 27% gain since a January low mostly reflects a rotational play on cheap valuations, and Chinese earnings are yet to convince, according to Lombard Odier, Pictet Asset Management, and Fidelity International. Even optimists like abrdn plc are harping on the need for companies to show profit gains.
On the surface, the investment case hasn’t been so compelling for a while as major benchmarks have roared into bull markets with policy support, with long-only funds no longer slashing positions. Yet, after years of underperformance from economic uncertainty and strategic competition with the US, the argument for Chinese stocks to be the major holding for emerging-market portfolios has long since run thin.
“Bear market rallies in China are not uncommon,” said John Woods, chief investment officer for Asia at Lombard Odier. “Do we tactically play these rallies and try to cleverly time entries and exits, or do we look through them and focus instead on earnings and fundamentals? Inevitably, we prefer the latter.”
The latest rally since April has surprised many, with Goldman Sachs Group Inc.’s analysts saying it had evoked a fear of losing out among traders. Chinese stocks have by now clawed back about $2.5 trillion or over one third of the combined market value lost in a historic meltdown that ended earlier this year.
Rotation from markets like the US, Japan and India, where stocks have soared to highs or near-records, compared with low valuations in China, was a catalyst. Overseas investors bought onshore stocks via trading links with Hong Kong for a third straight month in April, the longest such stretch in a year.
There will be continued rotation into Chinese tech firms from their global peers, particularly from the US, said David Mudd, founder and chief investment officer of PegasusAsia, a hedge fund. “It is also why there is a good possibility of outright divergence between China and US tech setting up interesting pair trades going forward.”
The MSCI China Index is currently trading at 10 times forward earnings, below its five-year average and 20.6 times for the S&P 500.
“The recent rally appears more to be a technical rebound given how cheap the market is currently, with valuations at historic trough, but its sustainability will depend on earnings outlook for the rest of the year,” said Nicholas Yeo, head of China equities at abrdn. “So far, companies sound optimistically constructive.”
Not everybody agrees.
Current consensus earnings growth for Chinese stocks at around 10% is “too high,” said John Lin, chief investment officer of China equities at AllianceBernstein. “The earnings expectation has to firm up and be supported by actual corporate performance. Neither of those things are happening yet at the moment.”
With the current earnings season still in full swing, the gauge’s constituents that had reported results as of May 13 saw a near 30% slump in net profit before exceptional items. Tech giants Tencent Holdings Ltd. and Alibaba Group Holding Ltd. will offer a fuller picture when they release earnings Tuesday, with their results seen as key to a sustainable rally.
Tencent is expected to post its slowest pace of revenue growth since 2022, while Alibaba will likely see its largest decline in almost two years in a key measure of earnings.
The other driver for the recent gains lies in signs of more policy support from Beijing, in particular a desire to clear unsold homes in the depressed property sector. At the same time, the likelihood of US policy rates staying higher for longer has turned Chinese stocks into an alternative, with its tech names benefiting.
The Golden Dragon Index, which tracks US-listed Chinese firms, rose 3.7% on Monday to the highest since September, spurred by an 11% gain in Tencent Music Entertainment Group after its consensus-beating first-quarter results. The Hang Seng Tech Index has advanced more than 30% since a January low.
“I have to say we are very tempted to add something into China and I know that some colleagues are already doing it, but that’s on a purely tactical basis,” said Luca Paolini, chief strategist at Pictet. “The reason why we refrain from being allocated significantly to China is because China will do well when the global market struggles a little bit.”
Morgan Stanley strategists including Laura Wang warned last week that investors shouldn’t chase the rally, though it didn’t rule out pockets of opportunities. That echoes what both bears and bulls are saying as Beijing pushed companies to increase dividends and buybacks, while providing incentives for strategic industries such as semiconductor producers.
“Once seen as hunting ground for growth-focused investors, now Chinese equities are increasingly surfacing in value-focused portfolios,” said George Efstathopoulos, a portfolio manager at Fidelity. Still, “earnings need to deliver and for earnings to deliver we need to see consumer sentiment improving in China, something that remains somewhat fragile today.”
–With assistance from Sangmi Cha and Ishika Mookerjee.
(Updates with US-listed Chinese stocks’ moves, more comments and earnings details.)
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