Have Chinese equities bottomed out? Trade war talks, infrastructure spending and boosted production all point to better days ahead
- John Woods says the global production decline appears temporary and China’s own infrastructure spending is picking up. Combined with possible progress in the trade war, this points to a path of recovery for China’s equities
Economics, of course, played a big part in the initial sell-off. The two key developments in this area were the slowdown in global industrial production and the failure of China’s economic data (especially credit and monetary data) to respond to or reflect fiscal and monetary stimulus unveiled in July. A closer look at both, however, suggests some encouragement going forward.
For starters, the weakness in global industrial production was not a broad-based slowdown but, rather, centred on discrete one-off factors, such as weather, strikes or manufacturing events. In particular, short-term emissions-related disruptions to the European and Japanese automobile sectors were pronounced, albeit temporary, and are now reversing.
While all this does not make a trend, the sudden and simultaneous appearance of data that all points towards an uptick in investment activity is positive news. Fiscal spending, if directed at shovel-ready infrastructure projects that have already been privately vetted, can be more readily expedited. This is unlike the current round of monetary stimulus, which is being stymied by the need to channel it away from sectors already saddled with excess capacity and towards credit-starved sectors like small and medium-sized enterprises.
Last, but not least, the outperformance of emerging market equities over US markets during the October sell-off reflects in part the amount of bad news already priced into emerging market equity in general, and China in particular. Certainly, China’s equity valuations are looking cheap, with history suggesting that such metrics do not remain at such extended levels for long. Ultimately, a mean reversion is inevitable; it is just a matter of anticipating the inflection point.
Here, it might be worth noting that the timing of a potential bottoming out of the earnings downgrade cycle seems to have slipped under the radar. The last two equity market cycles (2008 and 2015-16) strongly suggest that China’s equity market prices bottom out three to six months ahead of the trough in negative earnings revisions. And, with earnings downgrades potentially lasting another three to four months, signs of market consolidation should not be ignored.
It is perhaps not a coincidence that data from the Institute of International Finance for the first week of November showed inflows of US$5 billion into China equities, the largest weekly total in four years.
Just as there is a downside risk to being too optimistic, there is also a cost to being too negative for too long. We could be just one tweet away from a decisive turn in Chinese equities.
John Woods is chief investment officer for Asia-Pacific at Credit Suisse