When Morgan Stanley strategist Jonathan Garner downgraded China stocks in January 2021, he said it was the time for the market to catch a breather after emerging from Covid-19 and wait for other emerging markets to catch up.
That call turned out to be close to the top of a mega market cycle. The world’s second-largest equity market peaked, then crashed in the following month and has been mired in a painful slump for three straight years since then. Total market capitalisation of China’s onshore stocks has declined by more than a third to US$8.4 trillion, smaller than the combined worth of the three biggest US companies: Nvidia, Microsoft and Apple.
Garner, the US investment bank’s chief Asia and emerging markets strategist, who has been covering the region for more than two decades, believes the pain is far from over.
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“Hong Kong and China equities, onshore and offshore, may be in a secular bear market,” he said in an interview. “At least as far out as we can see it, this is not as attractive as other markets.”
The MSCI China Index, tracking more than 600 representative Chinese companies listed at home and abroad, has plunged by 55 per cent from its record high in February 2021. There have been several “countertrend rallies”, Garner said, including the six-month reopening play from October 2022 and the policy powered bull-run starting from April this year. None of them turned out to be sustained uptrends.
“The reason why we’re in that bear market is really quite straightforward,” he said. “Underlying economic growth is quite weak, and corporate earnings growth, consequently, is weak, particularly for US dollar-based investors.”
A patchy economic recovery following years of stringent Covid controls, coupled with a long-running property downturn and policy uncertainties, have all taken hold of confidence for domestic investors. Meanwhile the dismal track record and rising geopolitical tensions are putting off global funds, which have reduced their China exposure to near a historic low.
Beijing has rolled out some of the boldest measures ever to stem the rout, including direct intervention through buying of exchange-traded funds, crackdowns on short sellers and tightening the screws on IPOs to shore up sentiment.
However most of the efforts seem to have fallen flat. The Shanghai Composite Index slipped below the 3,000-point psychological floor again last week, erasing all of its advance this year, while the CSI 300 Index tracking the nation’s biggest companies has barely eked out a positive return.
“The key for the market to do better is that the consumer sectors, including e-commerce, need to generate better underlying revenue growth,” Garner said. “For the time being, we’re quite cautious about that.”
Jonathan Garner, chief Asia and emerging markets strategist with Morgan Stanley. Photo: Handout alt=Jonathan Garner, chief Asia and emerging markets strategist with Morgan Stanley. Photo: Handout>
For those seeking a silver lining in the cheap valuations, which are now hovering around a decade low, it is important to note that profitability is facing structural declines, he said. Corporate return on China equity in the middle of the last decade was around 17 per cent, roughly where India is today, but has fallen to around 10 per cent and continues to decline.
“With changes in the economy and business models, we see corporate margins substantially lower and asset utilisation tending to move lower,” he said.
Since 2006 when he joined Morgan Stanley’s Asia Research tea, which has topped Institutional Investor’s rankings for seven years in a row, Garner has often been a lone voice. In one of the most recent prescient calls made on May 9, he warned against chasing the China rally amid a wave of buying cheers from Goldman Sachs and UBS. The run has since cratered after peaking later that month.
China’s prolonged slump has also led to a meaningful reduction of its weighting in the MSCI Emerging Markets index, from around 45 per cent to about 25 per cent, with other major emerging markets such as India and Taiwan filling the gap.
Japan and India, the new darlings as investors look away from China, are both in “secular bull markets” and could continue to be attractive destinations for capital, Garner said. Both have very strong earnings growth of 15 to 20 per cent year on year, and domestic investors in both markets are very involved and are buying equity.
The Topix Index, which surged past its 1989 peak and registered a record high last week, could hit 3,200 by June next year, representing a roughly 11 per cent upside from the current level, according to Garner. India’s Sensex Index is also set to outperform the Shanghai Composite Index for the fourth straight year, he said.
“What is happening is that investor attention is much more broadly based in Asia than before,” Garner said. “Asian investors are focused on a wider range of opportunities than they were three years ago.”
This article originally appeared in the South China Morning Post (SCMP), the most authoritative voice reporting on China and Asia for more than a century. For more SCMP stories, please explore the SCMP app or visit the SCMP’s Facebook and Twitter pages. Copyright © 2024 South China Morning Post Publishers Ltd. All rights reserved.
Copyright (c) 2024. South China Morning Post Publishers Ltd. All rights reserved.
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