China A50 Outlook

A more encouraging China story is required to further boost its equity market and overall sentiment.

China equity markets have a comeback since late January thanks to the consistent policy support from central and local government.

China A50 (CHINAA50), an index of the 50 companies with the highest market capitalization listed on the Shanghai and Shenzhen stock exchange, added 9% YTD and jumped nearly 18% from January low. This trend is shared by other China proxies like MSCI China index, CSI300 and Hang Seng.

While the momentum is not as strong as Nasdaq or Hang Seng over the same period, A50 has showed at least some progress after years of weakness.

Not Good Enough Fundamentally

China’s official Manufacturing PMI unexpectedly dropped back below 50 in May after two months of expansion, missing the expectation of 50.5. While the annualized GDP growth rate has been above 5% for four consecutive quarters, the slowdown of manufacturing sector has put China’s economy under reality check again.

China has delivered tons of stimulus measures post-Covid (including the official property market rescue package released mid-May), with the result far from being satisfactory. The newly added social financing in April has turned negative for the first time since 2005. And more concerning is the growth rate of Total Social Financing keeps declining since mid-2022, which indicated the capital fails to flow into real economy or the demand is subdued. The Deposits de-accelerated even more quickly since 2023, not helping the consumption.

The stock market performance in recent months, in my opinion, is not matched by China’s fundamental picture. The old-fashioned rate cut or RRR cut remain in PBOC’s toolbox and more fiscal stimulus is underway. The market, however, need something more than that.

Lower Valuation

A50 is not the index that comes with the strongest momentum or return over the past 3, 6 or 12 months. However, mainland China has the lowest valuation (P/E) among the major economies.

More interesting, China’s stock market valuation to GDP ratio (Buffett Indicator) is less than 60%, vs 154% in Japan and 187% in the US. And the Equity Risk Premium or ERP for China market (forward P/E of Shanghai A-Share minus Chinese 10-year bond yield) is sitting at 7%, vs near 0 in the US. 

A significantly undervalued market with ongoing government support and reform is likely to attract more domestic and global investors. China indexes, therefore, have much room to run in medium to long term, with investment banks like Goldman Sachs and UBS already raising their forecast since May. 

For international investors, trading China proxy is not only a bet on China’s recovery, but also a way to diversify overall risk, especially when the US and EU markets have just peaked. 

Corporate Earnings Need to Catch Up

On corporate earnings level, while the revenue of listed Chinese companies is on the rise over past five years, corporate profit is flat and might take longer time to catch up.

What brings market some confidence is the well-performed blue-chips. For Q1 2024, China National Petroleum Corporation (CNPC) and China Petroleum & Chemical Corporation (SINOPEC) generated the highest quarterly revenue, meanwhile ICBC, CBC and ABC (three giant stated-owned banks) ranked the top 3 in terms of net income. All these above names are the key constituent of A50 index.

Consolidation Before Breakout

On the higher timeframe (weekly chart), the index is pressured by the negative trendline and 100-week moving average. A near term consolidation or pullback is more likely before an upward breakout.

The downside, on the other hand, is limited by the 50-day MA, which has been served as a key support in April and May. A break below it and the Jan-May trendline brings 12300 into vison followed by 12000.

A moderate retreatment can be considered a fresh opportunity for the bull.