When Morgan Stanley strategist Jonathan Garner downgraded Chinese stocks in January 2021, he said it was time for the market to take 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 stock market peaked, then crashed the following month and has since been in a painful recession for three years in a row. The total market capitalization of Chinese domestic stocks has fallen by more than a third to $8.4 trillion, which is less than the combined value of the three largest US companies: Nvidia, Microsoft and Apple.
Garner, the US investment bank’s chief Asia and emerging markets strategist who has covered the region for more than two decades, believes the pain is far from over.
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“Hong Kong and China stocks, both onshore and offshore, may be in a secular bear market,” he said in an interview. “At least as far as we can see, this is not as attractive as other markets.”
The MSCI China Indexwhich tracks more than 600 representative Chinese companies listed domestically and abroad, is down 55 percent from its record high in February 2021. There have been several “counter-trend rallies,” Garner said, including the six-monthly reopening the game from October 2022 and the policy-driven bull run from April this year. None of these appeared to be a sustained upward trend.
“The reason why we’re in that bear market is actually very simple,” he said. “Underlying economic growth is quite weak, and corporate earnings growth is consequently weak, especially for US dollar investors.”
A patchy economic recovery after years of strict Covid controls, coupled with a protracted recovery real estate decline and policy uncertainties have all chipped away at domestic investor confidence. Meanwhile, its dismal record and rising geopolitical tensions are deterring global funds, which have done so have reduced their exposure to China to almost a historic low.
Beijing has taken some of the boldest measures ever to reverse the defeat, including direct intervention purchase of exchange traded fundsrepression short sellers and tightening the screws IPOs to strengthen sentiment.
However, most efforts seem to have come to nothing. The Shanghai Composite Index fell below the psychological bottom of 3,000 points again last week, wiping out all progress this year, while the CSI 300 Index, which tracks the country’s largest companies, has barely delivered positive returns.
“The key for the market to outperform is for consumer sectors, including e-commerce, to generate better underlying sales growth,” Garner said. “We are very careful with this for the time being.”
Jonathan Garner, chief Asia and emerging markets strategist at Morgan Stanley. Photo: Handout alt=Jonathan Garner, chief Asia and emerging markets strategist at Morgan Stanley. Photo: Handout>
For those looking for a silver lining in cheap valuations, which are now hovering around multi-decade lows, it’s important to note that profitability is facing structural declines, he said. Corporate returns on Chinese equities were around 17 percent in the middle of the last decade, about where India is today, but have fallen to around 10 percent and continue to fall.
“With changes in the economy and business models, we are seeing companies’ margins being materially lower and asset utilization tending to be lower,” he said.
Since joining Morgan Stanley’s Asia Research team in 2006, which has topped institutional investor rankings for seven years in a row, Garner has often been a lone voice. In one of the most recent prescient conversations on May 9, he said which has been warned against chasing the chinese rally amid a wave of buy cheer from Goldman Sachs and UBS. The run has been going on ever since craters after peaking later that month.
China’s prolonged slump has also led to a meaningful reduction in its weighting in the MSCI Emerging Markets index, from around 45 percent to around 25 percent, with other major emerging markets such as India and Taiwan filling the gap.
Japan and India, the new darlings as investors turn their eyes away from China, are both in a “secular bull market” and could remain attractive destinations for capital, Garner said. Both are experiencing very strong earnings growth of 15 to 20 percent year-on-year, and domestic investors in both markets are highly engaged and buying shares.
The Topix Index, which soared past its 1989 peak and hit a record high last week, could reach 3,200 by June next year, which Garner said represents an increase of about 11 percent from current levels. India’s Sensex Index will also outperform the Shanghai Composite Index for the fourth year in a row, he said.
“What’s happening is that investor attention in Asia is much more broadly focused than before,” Garner said. “Asian investors are focused on a broader range of opportunities than three years ago.”
This article originally appeared in the South China Morning Mail (SCMP), the most authoritative voice covering China and Asia for more than a century. For more SCMP stories, please visit the SCMP App or visit the SCMPs Facebook And Tweet Pages. Copyright © 2024 South China Morning Post Publishers Ltd. All rights reserved.
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