Chinese stocks rebound, but foundation for rally still weak
Summary
Stocks in Chinese companies have bounced back, but investors have seen false dawns before.
Chinese stocks were the standout performers in the past month. The trillion-dollar question: Are they back for real this time?
The MSCI China index, which includes both domestically traded stocks and Chinese companies listed in Hong Kong and the U.S., has gained 10% since the end of March, outperforming other major indexes. The S&P 500, for example, has dropped 1.3% over the same period. The rally has brought Chinese stocks into bull-market territory: They have rebounded more than 20% from their January lows.
That is a stark turnaround after three straight years of losses. But investors have been burned by false starts before: The MSCI China index had surged 57% over three months starting in October 2022 on Covid reopening hopes, only to have most of those gains fizzle out as China’s postpandemic recovery turned out to be anemic.
There are certainly some fundamental factors underpinning the rally: China’s macroeconomic data last quarter has come out ahead of expectations, especially driven by a pickup in manufacturing. And while the housing market is still in the doldrums, Beijing recently signaled that it will come up with new plans to deal with the glut of unsold apartments.
What is more, after losing more than half of their value over three years, Chinese stocks look cheap. The Hang Seng China Enterprises index, a gauge of Chinese companies listed in Hong Kong, trades at just 8.9 times forward earnings even after the recent rally, compared with a 10-year average of 11.3 times, according to FactSet. Companies such as internet giants Alibaba and Tencent have stepped up their buybacks, which helped support their stocks.
Chinese stocks have also benefited from turmoil elsewhere. The prospect of interest rates staying higher for longer in the U.S. rattled some of the market’s overcrowded trades—like chip stocks—this past month. Money that has flown out of China into other markets dipped back. Institutional investors are still underweight in China relative to their benchmarks, but they have been increasing exposure to the country. For example, Asia ex-Japan funds and emerging market funds have reduced their underweight positions in China by 0.8 to 1 percentage point this past month, according to Morgan Stanley.
But corporate profits remain weak. The housing slump still weighs on domestic demand while falling producer prices are squeezing manufacturers’ margins. Analysts have cut their consensus earnings-per-share estimates for this year by 7% for stocks in the MSCI China index, according to Goldman Sachs, though some sectors, like internet companies, have gotten earnings upgrades.
The cheap valuations and the momentum of fund flows probably could keep the Chinese market going for a while. But a recovery in earnings growth will be needed for a more sustainable rally.
Write to Jacky Wong at jacky.wong@wsj.com
