Jovi Ho Published on Thu, Sep 16, 2021
The meltdown in Chinese equities from regulatory tightening has offset the strong equity performance in Taiwan, Australia, Singapore and India, raising concerns for worried investors.
As a result, the MSCI AC Asia Pacific Index has been relatively flat year to date, says Winnie Chiu, equities adviser at Indosuez Wealth Management’s markets, investments and structuring division.
Recent crackdowns have swept the education technology, video games and entertainment sectors in China. Companies that teach the school curriculum, for example, are now banned from making profits, raising capital or going public.
Speaking at the wealth manager’s 3Q2021 outlook on Aug 31, Chiu described China’s “reoriented target”, the driving force behind these abrupt policy changes. “After 10 years of effort to eliminate absolute poverty, Beijing is shifting its focus to balancing growth and sustainability,” she says.
“In 2012, when President Xi [Jinping] took office, Beijing proclaimed its key objective was to double income per capita and eliminate absolute poverty,” she adds. “Late last year, China declared victory over extreme poverty and reoriented their target to reach ‘common prosperity’ through a series of regulatory policies.”
“Common prosperity” is a catchphrase frequently heard from the world’s second largest economy, but what does China mean by the phrase?
“In an economic meeting [in August], President Xi laid out his plan by discussing common prosperity for the first time,” says Chiu. “He said China can support wealthy entrepreneurs who work hard, operate legally, and have taken risks to start businesses. But China must also do its best to establish a policy system that allows for fair income distribution.”
Gauging from Xi’s statement, common prosperity does not imply absolute equality. Rather, it describes balancing growth and profit-making with social fairness and competition, Chiu adds.
Despite the optics of recent actions, China’s common prosperity ethos does not necessarily mean a crackdown on the non-state sector, says Chiu.
In his column for Issue 1,000 (Sept 6, 2021) of The Edge Singapore, financial analyst Daryl Guppy likened the regulatory action to “corporate social responsibility driven by the State”.
The moves mirror the rising environmental, social and governance (ESG) concerns driven by shareholders in other markets, he argues.
“The ‘common prosperity’ pressure applied to rich individuals and their companies is derided by many in the West as evidence of the worst aspects of socialism. In principle, it is similar to the progressive taxation structure used by most Western countries, which aims to redistribute income from the rich to fund the provision of services to the poor,” writes Guppy.
According to Guppy, the message from China’s leaders is clear: “Invest in China as you would in the US and you will lose. Invest in China in companies that operate in a socially responsible manner and you will win.”
Likewise, Chiu reiterates that China is a one-party regime. Therefore, the pace and intensity of regulations have been more rapid and abrupt. “There could be an ongoing concern for investors in emerging markets like China [but] the policy adjustment should not be new to investors,” she says.
Chiu points to two periods of regulatory tightening in the past decade: the anti-corruption crackdowns between 2013 and 2015; and another in 2018 that took aim at gaming giants Tencent and NetEase.
Throughout these past regulatory cycles, the Hang Seng China Enterprises Index traded within the price-to-earnings ratio (P/E) band of between eight and 10 times. “Assuming all things equal and drawing from history, the index is now trading at 10.6 times P/E, [and] could see some further volatility,” she says.
That said, given the same historical indications, the market should recover meaningfully, she adds.
Who’s next, and when?
In the near future, food delivery platforms and property developers could remain under regulatory pressure, says Chiu.
In addition, coal-power producers could also be at risk, given pollution concerns and weakening demand.
When will these regulatory headwinds come to a stop? Chiu points to a few historical signposts for clarity, such as the roll-out of comprehensive regulations on platform companies, IPO approvals for FinTech companies and remarks by top government officials.
Despite the ongoing crackdown, Beijing has pledged support for SMEs, says Chiu. According to Vice Premier Liu He, SMEs are the main force and source of jobs in the market.
Along with that note, the People’s Bank of China reiterated in August that the central bank will maintain a stable monetary policy to encourage increased funding to SMEs, technological innovations and green development.
“The market expects another 50-basis-point cut in the coming months, and this pledge to boost credit should serve as a positive signal to the market,” says Chiu.
On the other side of the spectrum, domestic consumption “should hold up well” as the income gap narrows and spending power continues to increase.
Insurance asset companies, in particular, should see higher demand for people looking to diversify their financial risk, she adds.
On the energy front, the country’s 14th five-year plan, unveiled in March, sets a 18% reduction target for “CO2 intensity” and 13.5% reduction target for “energy intensity” from 2021 to 2025. “The push for environmental standards will boost the demand for lithium, solar glasses and also natural gas,” says Chiu.
While China has seen few Covid-19 cases this year, its zero-tolerance approach, shown in a recent case at a Chinese port, has slowed economic activity in the past two months, she adds.
Located on the coast of the East China Sea, the combined Ningbo-Zhoushan Port is the third-largest container port in the world. The key terminal was suspended for a fortnight in August after a single infection case was found among its 100,000 workers.
“The closure of Chinese ports and the rise of the Delta [variant] has caused a ripple effect on overall shipments,” says Chiu. “On the macro front, growth indicators fell short of expectations in July as a result of floods in Henan, containment of the Delta variant and also regulatory issues. Looking into the third quarter, China’s trade activities should see further slowdown.”
While there are risks in China, its longterm growth trends are very much intact, says Chiu. “We are neutral towards China equities in the short term, but optimistic for the medium to long term. We suggest investors diversify and exercise patience on their Chinese equity holdings. As the economy undergoes normalisation, regulatory tightening could persist. But we can see clearer signs of stabilisation from Beijing.”
Asia Pacific’s “speed bump”
In the Asia Pacific region, Singapore, Hong Kong and Malaysia should achieve 90% vaccination rates by the end of the third quarter, says Chiu.
That said, the fast-spreading Delta variant has set off a sharp increase in daily infections in Malaysia, India and the Philippines.
Citing data from JP Morgan, Chiu expects both Singapore and Malaysia to continue their growth trend, though Malaysia’s GDP outlook “could be less solid”, as the country battles rising cases.
“Altogether, we believe that the region is actually facing a temporary speed bump, but we do not see a permanent roadblock to growth recovery,” says Chiu.
Elsewhere within the region, Chiu finds South Korea attractive as well, although the earnings outlook appears marginal for now.
Over the past three months, South Korean companies have seen the second-highest earnings upgrade for FY2021 in the region. “We prefer companies and industries like semiconductors, IT and banking, which have long-term tailwinds of growth,” she says.
While Taiwan saw the highest earnings upgrade, Taiwanese companies’ P/E is 25% higher than that of South Korea, says Chiu. Given this and Taiwan’s low vaccination rate, Chiu is underweight on Taiwan.
Indonesia and the Philippines may look “exciting on the surface”, but Chiu is neutral on the two Southeast Asian markets due to their low vaccination rates, sharp increase in infection numbers and recent earnings downgrades.
By the same token, Indosuez Wealth Management’s underweight recommendations on India, Thailand and Malaysia are the result of stretched valuations, dull earnings outlook and a higher threat of Covid-19 outbreaks, says Chiu.
Meanwhile, Singapore’s high level of vaccinations has supported the reopening of the economy and its future growth outlook, says Chiu, who is overweight on the Singapore market.
“We are optimistic towards banks, retail REITs and healthcare, which have shown resilience in the current environment. If reopening efforts remain on track, we will also be looking at hospitality names,” she says.
Photos: Bloomberg