China macro and market: 2022 outlook slightly better
The Chinese (offshore) equity market has suffered heavily over the past year, dropping by more than 30%, which is the sharpest 12-month decline since the global financial crisis. This, however, largely reflects the effects of government regulatory intervention rather than a lack of economic support. While the purchasing manager indices (PMIs) of the country have continued to improve over the past 12 months, credit impulse (change in credit growth) which is a key driver of economic growth and the equity markets in China, troughed in May last year, before recovering throughout the second half of 2021. Instead of following the credit impulse higher, Chinese equities suffered from a heavy onslaught of regulatory measures. These did not only weigh on sentiment, but brought down earnings as well.
Profitability slumped as a result, with return-on-equity (RoE) of Chinese equities almost returning to the recession lows in 2020. At the same time, RoEs of global equities and of euro area equities recovered to the highest levels in more than 10 years. Yet, the market has more than priced for this divergence. The price-to-book (PB) ratio of Chinese equities has dropped below 1.3x, which is not only the lowest level in six years, but also materially below euro area PBs. This has happened only twice over the past 15 years. In other words, earnings have dropped sharply, with worsened performance.
Most recently, Chinese equities rebounded on government statements vowing to prioritize financial market stability and complete the regulatory process of Internet platform firms as soon as possible. They suggest that regulatory processes should be transparent and predictable. The government also reiterated its commitment to more policy support [for the economy] and emphasized domestic stability.
If regulatory headwinds were to abate, a brighter macro outlook could be expected for the second half of the year and that could help extend the most recent rally in Chinese equities. There are signs that the macro picture has improved, but a lot will still depend on the effectiveness of impending government stimulus.
Latest macro indicators surprised on the upside. Industrial production grew 7.5% on a yearly basis, compared to 4.3% in December. Sequential growth was slightly weaker, however. Retail sales jumped from 1.7% in December to 6.7%, and fixed asset investment, driven mainly by manufacturing and infrastructure investment, accelerated from 2% in December to 12.2%. The real estate sector remained weak though with housing starts growth at -14.9% and real estate sales growth at -22.1%. House prices also fell slightly in February.
We continue to expect growth to improve from Q2. Central government spending has been slow so far (YTD at 1.7%), but is set to increase, and infrastructure spending by local governments will ramp up. In addition, the relaxation of real estate policy restrictions has already started at local level. A few cities have lowered down payment requirements and some have started relaxing home purchase restrictions. These measures should help stabilise activity by Q3. Stronger growth for the rest of the year also implies stronger credit growth than what we saw in February.
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