Goldman Sachs believes China’s biggest stocks in onshore and offshore markets can rally by 20 per cent over the coming months. At least seven hurdles are blocking the recovery path, the US bank said.
Demand for diversification from China-mandated investors, slowing economic growth and corporate earnings, lack of forceful policy easing, disillusioned foreign funds, and underlying geopolitical risks are some of the reasons its buy recommendation since late last year has not quite paid off.
“The strategic case remains intact, but [we] acknowledge that assessing the case has become more complicated,” strategists including Kinger Lau said in a report on June 2. “Demand for diversification among China-mandated investors has risen” as risks to the economy and market are amplified with Covid-induced lockdowns.
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While the so-called ‘China Put’ or policy backstop has been activated as top Beijing officials refocus on reviving growth, more aggressive measures are needed to restore consumer and corporate confidence, they wrote. Besides, consensus forecasts on earnings “are still too optimistic and more downgrades are likely”, they added.
The challenges underscores why foreign investors have taken a patient stance before committing more money to the market. China’s zero-Covid policy has triggered lockdowns in 40-odd mainland cities this year, reducing the economy to an unpredictable stop-start pattern while clouding earnings outlook.
“We expect the strength of any potential rebound of the Chinese economy to be moderate in the absence of any meaningful changes in the Covid policies and more decisive stimulus measures,” Pictet Wealth Management said in a May 24 report. “China’s recovery is likely to be slow and limited.”
The MSCI China Index, which tracks 744 stocks at home and abroad, has dropped 17 per cent this year on top of a 21.6 per cent loss in 2021, erasing US$2.5 trillion of market value in that 17-month span. It underperformed the MSCI All-Country World Index by 35 percentage points over the same period.
While Chinese stocks may be near the end of an extended slump, it is not the right time to dive in just yet, according to Morgan Stanley. Investors should be patient because the full brunt of corporate earnings has yet to play out, strategist Laura Wang said last month.
Goldman forecast in March the gauge would rise to 84 points over 12 months, implying a 20 per cent upside. Its base-case scenario is for corporate earnings to bottom out in the third quarter, with the market trading at about 15 per cent discount to fair value in terms of price-earnings multiple.
While additional fiscal stimulus is likely to come, Goldman is banking on more predictable Covid lockdown policy, better communicated reopening timetable and more concrete policy action by the government to showcase its support for the private economy.
China wants to achieve about 5.5 per cent annual growth this year, a level that looks unattainable as some analysts cautioned China will not forgo its zero-Covid policy before the Communist Party’s Congress in October or November. Goldman and other Wall Street peers and some Swiss private banks have cut their forecasts because of the drag from Omicron-related disruptions.
Still, there are some favourable signs. Domestic regulatory reforms have since eased, while geopolitics proxies tied to US-China relations and potential secondary Russia sanctions suggest those concerns are mostly priced into equities.
Goldman remains overweight on Chinese A shares and offshore-listed companies given the policy backstop. It picked 50 stocks based on its thematic baskets of stimulus beneficiaries, state-owned developers, internet-sector players and Covid recovery plays.
Additional reporting by Zhang Shidong in Shanghai
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