The Chinese Stock Market Sharply Declined in the 3Q 2022, due to the Chinese government Instituting Lockdowns and the Property Market Getting Worse.
The Hang Seng China Enterprise Index declined by 22.9%, mainly because of two reasons. firstly, the Chinese government remains very committed to its zero-covid policy where they institute harsh lockdowns and social distancing measures in areas that have covid-19 cases. This has worked for the government in the 2020 pandemic, where they did the same thing on a national scale and had one of the lowest rate of infection in the world. However, one thing is different from then. There were no vaccines back then, and there are now. It is still perplexing at this stage that the government remains committed to this policy when most of the world is shifting to living with Covid-19.
The second reason, is the downturn of the property market. You might have heard some things about homebuyers refusing to pay for their loan installments until the house is shown to being completed. This was triggered by Evergrande having massive difficulties in servicing their debt and completing their housing projects. Homebuyers got spooked and refused to pay. In the past 4 months, house prices have actually been declining and Evergrande’s troubles is not just confined to it, but to many property players in the market where they also have funding difficulties to complete the housing projects. Why is this such a big deal? Most of Chinese household wealth is concentrated in housing, and the percentage of household wealth in property is one of the highest in the world.
8 out of 11 sectors in the Chinese Stock Market, declined by more than 10% during the 3Q 2022, making this one of the worst years on record.
Healthcare, materials, technology and consumer discretionary sectors led the awful decline in the Chinese stock market. Healthcare sector declined on obvious reasons. It went up sharply during the pandemic, as most investors sought healthcare stocks that saw their earnings double or triple for increased demand for healthcare services and equipment. That party has to come to an end someday. Materials sector declined too because of two reasons — increase in global commodity prices that lead to materials companies incurring higher production cost as they import most of the raw materials and the lockdown restrictions hampered their operations.
Technology sector is a sad case here. The Big 4 tech companies of Alibaba, Tencent, Baidu and Xiaomi were affected by local government regulations on the sector. Alibaba suffered from anti-monopoly regulations instituted by the government, and even had to pay a fine. Let’s not get into how Jack Ma is so silent these days too. Tencent and Baidu are suffering from increased regulatory crackdowns on video gaming and education sectors that have reduced their advertising and video gaming revenue. Consumer discretionary sector suffered from the lockdown restrictions imposed on the economy.
The HSCEI market earnings are projected to grow by a strong 25.8% in 2022, driven by Industrials, Consumer and Technology Sectors.
While the Chinese stock market has been on a downturn for the year, earnings of the companies are still projected to grow at a strong rate of 25.8%. For comparison, it has been growing at an average of 11% over the past 3 years. Industrials are projected to grow at the strongest rate of 34.1%, followed by Consumer (+30.9%), Technology (+30.0%), Telecommunications (+29.2%) and Healthcare (+25.1%).
There are essentially 3 events in China that are important to take note of — the development of local mRNA vaccine, recovery of the property sector and changes in the Politburo Standing Committee.
The development and roll-out of the local mRNA vaccine means that China would not have to rely on zero-Covid policy to curb increase in Covid-19 cases. Clinical trials are already ongoing for mRNA but there are no approval yet. The property sector recovery will essentially hinge on how well the government handles the funding problems of developers in China. On 16 October 2022, the Politburo Standing Committee will see fresh selections of leaders for China’s highest leadership committee which includes the current President Xi Jinping. Two leaders are expected to make way for younger members as they exceeds the age limit. Investors will be closely monitoring the progress of the Politburo Standing Committee selection for any changes in official policy stances.
The Chinese stock market is essentially fairly valued now, but the outlook for the stock market remains uncertain in light of recessionary risks in the global economy and local developments.
The HSCEI is currently trading at a price earnings ratio of 22.8 times, similar to the 5 year average of 24 times. This indicates that it is fairly valued at this moment in time. Investors are positive on the sectors of consumer, technology, telecommunications, utilities and industrials with price earnings ratio trading higher than the market of 22.8 times. However, these high valuations are clouded by the risks of a potential global recession in 2022 and 2023, as global interest rates continue to rise in light of inflationary pressures. China in this regard is deeply interconnected with the global economy with its status as the world’s factory. Local developments of lockdown restrictions and property market recovery will also have a big impact on the stock market performance in the short-term.
