Government stimulus and low valuations create upside for Chinese stocks

Chinese equities have been on a wild ride since policy-makers unveiled bold stimulus measures in late September to boost the country’s struggling economy and stock market.

China’s CSI 300 Index, which tracks onshore stocks, rallied more than 30 per cent within days of the Sept. 24 announcement but has lost close to one-third of those gains amid worries about another false dawn.

Although some investors are frustrated with China withholding the size of its new fiscal spending and its drip-fed stimulus approach, some portfolio managers are bullish on the market.

Tyler Mordy, chief executive officer and chief investment officer at Kelowna, B.C.-based Forstrong Global Asset Management Inc., calls the stimulus “the significant event we have been waiting for.”

“That is the policy bazooka,” he says. “Looking out one year, there is a strong probability the Chinese market will be higher.”

The People’s Bank of China (PBOC) announced its stimulus package amid concerns about whether China can meet this year’s 5-per-cent growth target and end its housing slump and deflationary pressures.

The new measures included interest rate cuts, reductions in existing mortgage rates and plans to recapitalize banks and support the stock market.

Although China’s finance minister didn’t disclose a price tag for the fiscal stimulus – as the market had hoped – during last Saturday’s press briefing, he did provide forward guidance, Mr. Mordy says. “Fiscal policy will focus on supporting the property sector and alleviating local government debt burdens.”

Key is that “Beijing has broken free of its policy paralysis,” he adds. “The central question is whether China is serious about reversing negative sentiment and restoring confidence. We believe it is.”

But the big takeaway from the stimulus package is that China wants to prop up its stock market, says Mr. Mordy, whose team runs the actively managed Forstrong Emerging Markets Equity ETF FEME-T.

The PBOC plans a swap program to let mutual funds, brokers and insurers have easier access to funding to buy stocks. It will also provide cheap loans to commercial banks to extend credit to listed companies so they can buy back their own shares.

“What they are trying to do is reignite animal spirits and put a floor under capital markets and reignite risk-taking,” Mr. Mordy says.

Fiscal support is planned through increased assistance to low-income households and the “long-term unemployed,” he adds.

It’s probably early to analyze the size and efficacy of the stimulus so Chinese stocks are likely to remain choppy, he says. “We will likely increase our China exposure on any further market weakness.”

The downside is relatively low and “upside is enormous because you have cheap valuations, the prospect of more policy and things stabilizing there,” he says.

Forstrong Emerging Markets Equity ETF is playing China mainly through funds, such as KraneShares CSI China Internet ETF KWEB-A, which owns Chinese internet companies, and KraneShares Bosera MSCI China A 50 Connect Index ETF KBA-A, which tracks mainland China stocks.

Many foreign institutional investors have given up on China, as can be seen by the proliferation of some 13 U.S.-listed emerging markets exchange-traded funds that exclude China, Mr. Mordy says.

“It will take a while to engineer confidence, but this is more about a domestic story,” he says. “We are relying on the domestic investor as the first thrust in a bull market.”

Regina Chi, vice-president and portfolio manager at Toronto-based AGF Investments Inc., agrees that China’s latest policy is significant, but describes it as a “mini-bazooka” in terms of liquidity stimulus.

“The market has been disappointed by its drip monetary and fiscal policy,” says Ms. Chi, who oversees AGF China Focus Fund as well as emerging markets mutual funds.

But there should be “some concrete numbers” on fiscal expansion when the Standing Committee of the National People’s Congress, China’s top legislature, meets at the end of October, she adds.

China’s government has said it has more room to borrow and raise the deficit, she says. “There are rumours that it may raise 6 trillion yuan (US$850-billion) from ultra-long special treasury bonds over the next three years.”

And local governments will be able to issue special bonds to buy unsold homes to reduce housing inventory and “put a floor” on real estate.

Ms. Chi was bullish on the Chinese market before the recent stimulus package. It has been trading cheaply at about 10.5 times forward earnings versus 22 times for the U.S. market, and at a discount to other emerging markets, she says.

“I also believed the Chinese government would do the right thing in terms of stimulating and it was just a matter of time,” she adds. “With China, you have to be patient.”

The difference in China’s new stimulus measures versus 2008 and 2015 is that it’s “not throwing money into fixed-asset investments such as roads and manufacturing,” she says.

Household savings in China, she notes, make up 40 per cent of gross domestic product, so the government wants to unleash consumer spending to have a positive impact on the broader economy and encourage businesses to reinvest. For instance, the government is giving consumption vouchers to buy goods at a discount, she says.

For AGF China Focus Fund, Ms. Chi favours consumer discretionary names such as Alibaba Group Holding ADR BABA-N. Its revenue growth will pick up as the economy rebounds and consumer confidence increases, she says.

Tencent Holdings Ltd. ADR TCEHY is also a large holding. It’s the market leader in gaming globally and has the largest digital platform for social media, she adds.

Arup Datta, senior vice-president and head of the global quantitative team at Mackenzie Investments in Boston, is “cautiously bullish” on China’s market.

It’s “still pretty cheap compared with many other markets in the world” but has been lacking a catalyst, says Mr. Datta, a portfolio manager who oversees Mackenzie Emerging Markets Fund and Mackenzie Emerging Markets Fund II.

“If you have a long enough window, it does work out, but you need that long enough window.”

Lately, China’s government seems more serious about stimulus measures to bolster its economy but the key question is how much it will spend, he says. “The devil is [still] in the details.”

Mr. Datta’s emerging markets funds are now overweight Chinese stocks by about 2 to 3 per cent compared with the MSCI Emerging Markets Index.

Some China-based names he favours are Shanghai-listed Yutong Bus Co. Ltd., a global manufacturer of buses and coaches, and China Tower Corp. Ltd. CHWRF, a telecommunications company.

China’s environment differs from 2008, when it responded to the global financial crisis with a large stimulus package, because it also needs to deal with a “huge real estate bubble, and those things take time to work out,” Mr. Datta says.

The market is hoping China can still achieve its 5-per-cent growth target. “I do believe that the Chinese government will take directional steps, but the question is whether it will be quick and large enough.”