If you have been investing in China or Hong Kong-listed equities in the past few years, there is a good chance you are underwater on your investment. China equities performed poorly last year, declining to a level never seen in the past decade. Let that sink in!
Hang Seng Index (HSI) 2021-2022 bear market reached the level last seen in 2009.
What happened in China?
Various factors contributed to this poor performance, with government policies being the most significant contributor. In August 2020, the Chinese government introduced the “three red lines” regulation to ‘safeguard’ the property sector. Many Chinese property developers at the time were already highly leveraged, with the notable one being Evergrande, already failing on all three red lines. Many of these highly leveraged developers could not borrow anymore due to the new regulation, causing a credit strain, with some of them starting to default.
The Chinese government also started to crack down on Chinese tech companies. The highly anticipated Ant Group IPO was canceled last minute upon government request. Didi also got delisted from NYSE. An antitrust guideline was introduced, citing monopolistic behaviors and unfair competition among the tech giants. Alibaba was fined a record $2.8 billion in a landmark antitrust case in China. Other crackdowns in the gig economy sector, gaming, and for-profit private education also exacerbated the situation.
And then there is the zero-COVID policy. While the world was already starting to open up and live with COVID, China persisted with its zero-COVID policy. With the whole nation always in perpetual lockdown, the Chinese economy slowed down, and the market tanked.
Bullish Theses and Risks
Investors speculate that the various government policies which initiated this bear market may be normalizing soon. Some good news has been popping up recently. In this article, we will look into some of the bullish theses and some of the risks of investing in China.
Bullish Thesis: China Reopening
In a bit of a surprise move, the Chinese government finally reviewed and bade farewell to its zero-COVID policy, readying itself to restart its economy and opening up its border. This reopening narrative, in our opinion, is one of the most bullish theses for the China equities market this year.
We expect a gradual normalization of the Chinese economy, with consumption and economic activity gradually increasing again. We believe this may positively impact the market this year with quality companies that have healthy margins and operating efficiency to excel.
Bullish Thesis: Easing Policy
To support the gradual reopening of the economy, we expect the central bank to continue its easing policy to ensure a smooth reopening of the economy. This is in contrast to their western counterparts, which are currently struggling with high inflation. Almost all western countries, including the US and Europe, are now in a tightening cycle, with rate hikes and quantitative tightening being the norm.
In our opinion, a supportive easing policy is usually good news to the market. We believe the market may do relatively well due to this policy.
Bullish Thesis: Resolution on the Tech Companies Crackdown
China’s two-year crackdown on its tech sector is expected to end soon. The central bank’s top official has signaled that the supervision will be normalized, and support will be provided to help the sectors grow globally. In the recent news, Jack Ma has given up majority control of the Ant Group, which may pave the way for the Ant Group to go public again. In our view, this policy normalization will help China’s tech industry to recover after experiencing one of its worst performances last year. We also expect a warmer reception from international investors with this policy normalization.
Bullish Thesis: Valuation is relatively cheap
Hang Seng Index (HSI) is one of the most common ways for international investors to have exposure to the broad Chinese market. As of this writing, HSI stands at a relatively cheap valuation, ~10 P/E ratio, with a 3-yr average P/E of ~12.3. Alibaba (BABA), one of the most popular stocks among international investors, has a forward P/E of just 12.7. Companies with a strong balance sheet and fundamentals that can weather potential recession will likely do well in the coming years.
Bullish Thesis: Change of trend signals in the Hang Seng Index
From the technical perspective, Hang Seng Index (HSI) has finally signaled a trend change from bearish to bullish. Nothing is guaranteed, but we have seen several signals that indicate the bear market may have ended. At the time of this writing, we have seen these signals which historically suggest a change of trend:
- A rally from the market bottom of >20%. Currently, HSI has rallied ~48% from the market bottom.
- A break above the 200 moving average.
We are still waiting for another signal: when the shorter-term moving average crosses up the longer-term moving average. It is yet to happen, but if the momentum stays, this cross will happen sooner rather than later.
Now that we have presented some of the bullish theses above, you will also need to understand some inherent risks associated with investing in China.
Risk: Government control
This risk is not specific to China but applicable to all markets. You need to be aware of how the government can influence the market. With the Chinese market, we have seen how much power the sudden government policy introduction can impact the market. If you want to invest in China, always be comfortable with such influence on the market.
Risk: Geopolitical risks
The ongoing tension between China and Taiwan is one of the main geopolitical risks investors should be comfortable with before investing in the Chinese market. With the US indirectly behind Taiwan, a conflict may result in the two largest economies colliding.
Risk: Aging Population
Last year, the population of China declined for the first time in six decades. Population growth naturally promotes economic growth. An aging demographic usually indicates a maturing economy which means the era of high economic growth may be over.
Summary
The Chinese market performed poorly in 2022, contributed by government policies and crackdowns that targeted various sectors. Starting in 2023, investors believe the reversal may be coming, and the resolution to the crackdowns may also be coming to fruition soon. With the reopening narrative and the easing policy in place, we believe the worst for the China equities may already be behind us. We may also see the outperformance of the Chinese market against its western counterparts, which are still struggling with high inflation and a potential recession.
How to get exposure to the China equities market?
Here are the most common ways international investors can have access to the Chinese market:
Hong Kong-listed stocks, indexes, and ETFs
This is the preferred way for most international investors as this is usually the primary listing for Chinese companies to go public. Note that the currency in the Hong Kong Stock Exchange is Hong Kong Dollar. Here are some of the largest mega-cap companies listed on the Hong Kong Stock Exchange:
- 9988 – Alibaba Group Holding Limited
- 0700 – Tencent Holdings Limited
- 9618 – JD.com, Inc
- 9888 – Baidu, Inc
- 3690 – Meituan
- 1810 – Xiaomi Corporation
- 0939 – China Construction Bank Corporation
- 0941 – China Mobile Limited
- 0883 – CNOOC Limited
- 2318 – Ping An Insurance (Group) Company of China, Ltd.
If you prefer an ETF that tracks these largest companies, you may consider the following:
- 3067 – iShares Hang Seng TECH ETF
- 3033 – CSOP Hang Seng TECH Index ETF
- 3115 – iShares Core Hang Seng Index ETF
- 3037 – CSOP Hang Seng Index ETF
US-listed stocks, indexes, and ETFs
For US investors who do not have access to the Hong Kong Stock Exchange, you may consider buying the stocks or ETFs directly from the US stock exchanges. However, note that many of these stocks were listed via Variable Interest Entity (VIE) structure. Some of the mega-cap stocks and ETFs listed in the US are:
- NYSE: BABA – Alibaba Group Holding Limited
- Nasdaq: JD – JD.com, Inc.
- Nasdaq: PDD – Pinduoduo Inc.
- OTC: TCEHY – Tencent Holdings Limited
- Nasdaq: BIDU – Baidu, Inc.
- NYSE: NIO – NIO Inc.
- Nasdaq: MCHI – iShares MSCI China ETF
- NYSEARCA: KWEB – KraneShares CSI China Internet ETF
- NYSEARCA: FXI – iShares China Large-Cap ETF
