Five key themes of China A-shares

March 15, 2021 09:15
The new energy and electric vehicle sectors are expected to outstrip the traditional fossil fuel-related industries to become the winners in the sustainability theme. Photo: Reuters

Chinese equities volatility has always been relatively high, especially under extreme market conditions, therefore dollar-denominated assets have often been considered as ‘safe haven’. The situation, however, was completely different last year. Not only did the Chinese stock market outperform its U.S. counterpart, volatility was also much lower. In 2020, the S&P 500 Index recorded daily volatility of more than 5% for ten trading days on average, while the MSCI China A-share Index and MSCI China Index recorded that level of volatility for only three and two days respectively.

In 2021, we expect high single-digit growth in China’s GDP as most economic activity has resumed, which will also contribute to the recovery in corporate earnings. Given the backdrop, the five key themes below are worthy of investors’ attention:

While the pandemic situation is still severe in other parts of the world, China has been doing a better job in the fight against the pandemic. The difficulties and hurdles for people in China to travel abroad actually benefits local tourism, which favours duty-free shops and hotels.

Infrastructure projects continue to support economic growth and drive demand for machinery in China. Furthermore, under the policy of “internal circulation”, the market share of local component manufacturers is expected to increase.

As the population ages, healthcare expenditure will continue to increase. The prospect for the medical and biotechnology sectors is attractive, especially in offshore markets such as Hong Kong.

The Chinese government is committed to carbon neutrality by 2060 by promoting the development of new energy sources. As the cost of solar energy declines gradually, it is expected to reach grid parity this year, which greatly enhances the competitiveness of the sector. The new energy and electric vehicle sectors will outstrip the traditional fossil fuel-related industries becoming the winners in the sustainability theme.

Last but not least, China’s latest five-year plan focuses on “internal circulation” and technology, therefore technological innovation sectors such as semiconductors, 5G and new energy industries will be in favour.

After the market rally last year, the P/E forecast for the MSCI A-share index is now around 17 or 18 , which is one standard deviation higher than the historical average (14).
Has the factor of economic recovery been reflected in the equity market? Undoubtedly, the price of A-shares will remain high in the short term, but investors do not need to be overly worried about the valuation, because the market is supported by corporate earnings. Also, China’s economy continues to show stable growth, which will be able to support higher valuations.

In addition to the A-share market, investors may also expand their investment landscape to seize other opportunities across the whole array of Chinese equities, meaning they could consider investing in China A-shares, as well as Chinese ADRs listed in the U.S. and stocks listed in Hong Kong in one shot. As global liquidity remains abundant and the valuation of H-shares is slightly lower than that of A-shares, Chinese capital has been flowing into Hong Kong shares in recent months and become a new driving force in local financial markets.

In short, the Chinese stock market has shown its strength with greater resilience and lower volatility last year as compared to other global markets. With China effectively controlling the pandemic, the economy continues to improve, which stimulates corporate earnings to grow continuously and creates more investment opportunities. However, due to the fast-paced sector rotation in the A-shares market, leading industries may fall behind rapidly. Therefore, it is important to be nimble in capturing the opportunities and managing risks.

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Portfolio Manager on Chinese stocks, Allianz Global Investors