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China Sector Leader Review and Outlook 2022

As we see off 2021, many will remember it as the year of regulation. Chinese policymakers normalised monetary and fiscal policies and tightened regulatory measures across a number of sectors, igniting a push towards common prosperity to address the chronic income inequality brought on by decades of astronomical economic growth. As policymakers committed to a balancing act between security, supply-chain self-sufficiency and social equality, geopolitical tensions caused significant market volatility.

What’s Next After a Year of Regulation?

It was a roller-coaster ride for equity markets. Issuances for domestic mutual funds reached new highs, kicking off a broad-based market rally before the Chinese New Year. Economic recovery continued into the second quarter of 2021, with second-quarter gross domestic product year-on-year growth reaching 18.3%. 1

However, a series of new regulatory requirements for data, fintech, carbon emissions, after-school tutoring and property interrupted the Chinese economy and led to a significant underperformance in the MSCI China over the course of the year.

A combination of property tightening and a resurgence in COVID-19 triggered a slowdown in retail sales, while power shortages dragged on GDP growth to below 5% in the second half of 2021.2 Markets started to stabilise as policymakers started to ease up on directives in the fourth quarter of 2021. Yet this was short lived as de-listing concerns re-emerged in December, causing a significant drop in Chinese American depositary receipts (ADRs)—negotiable certificates issued by a US depositary bank representing a foreign company’s stock—across industries.

Valuations Remain Attractive

The MSCI China Index de-rated and lost over 15% year to date, significantly underperforming global equities.3 As a result, Chinese equities are considerably more attractive from a price/earnings-to-growth and price-to-book perspective from a historical range, especially considering that new economy companies now account for a bigger portion of the index.

Despite a whirlwind 2021, the intensity of the regulatory crackdowns is likely to moderate. As the Chinese government pivots towards a cross-cyclical policy framework, we’d expect adjustments to be much more subtle in the new year.

Market Outlook: China’s Balancing Act Between Growth and Sustainability

China has clearly prioritized social objectives over economic growth. Yet a slowdown in growth has hit levels policymakers can no longer ignore. The Chinese Communist Party’s 20th National Party Congress in the fourth quarter of 2022 should see changes within the top levels of the Politburo Standing Committee. That said, stability will be key to ensure a smooth transition.

Looking ahead, the Chinese government will have to play a balancing act between growth and sustainability, targeting a 5% gross domestic product (GDP) growth target for 2022, in our view/we expect. The Chinese government’s shift towards a cross-cyclical policy framework, while sparse in details, aims to pre-emptively smooth out any fluctuations in growth through smaller policy adjustments. This is a pivot away from the country’s long-preferred counter-cyclical policy used to stimulate the economy.

Under the government’s new policy framework, housing will no longer be a preferred counter-cyclical tool to stimulate the economy. However, we do not expect any further over-tightening or systematic risk either. The gap between producer price index (PPI) and consumer price index (CPI) is expected to narrow—PPI is likely to peak off while CPI may pick up in in the second half of 2022. While infrastructure investment is likely to accelerate to partly offset the potential moderation on exports as global supply chain to gradually normalize as COVID-19 gradually fades out. Yet, property policy will likely be the biggest uncertainty factor for growth in 2022.

With a moderate growth environment we expect secular growth sectors to see a boost from policy tailwinds that favour clean energy related businesses. In spite of the regulatory crackdowns we saw in 2021, the intensity should moderate and is unlikely to alter China’s long-term policy goals. As a result, regulatory action affecting China’s internet and property firms are likely here to stay as the country transitions into the implementation phase of its regulatory schedule. While ongoing delisting concerns have impacted investor sentiment and valuations, this should have been mostly digested in 2021 and should have limited impact on company fundamentals as we head into the new year.

That said, a zero-tolerance COVID-19 policy and a resurgence in the new variant places the biggest uncertainty for the retail and services industry. Geopolitical risk is another known unknown—we saw some improvement in the Sino-US relationship over the year, but whether both sides can make substantial progress in trade and roll back tariffs remains to be seen.

Daniel Zhou
Senior Investment Analyst (North Asia Financials)

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1. Source: National Bureau of Statistics of China, July 2021.

2. Source: National Bureau of Statistics of China, January 2022.

3. Source: Bloomberg, December 2021.

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