Chinese stocks have been on an uptrend since early April, delivering over 10% returns in US dollar terms. Major indexes like MSCI China, Nasdaq Golden Dragon, and CSI 300 have all rebounded sharply from their late January lows, gaining nearly 27%, 22%, and 14% respectively.
According to UBS strategists, there are multiple factors driving the strong performance of China stocks.
Specifically, first-quarter macroeconomic indicators exceeded expectations, and the economic and regulatory policy tone has become more supportive. In April, guidelines addressing investor concerns around minority shareholder interests and listing quality were released.
Also, the April Politburo meeting signaled intentions to tackle housing inventory issues, leading some analysts to anticipate more aggressive supply-side property stimulus. This mix of catalysts has modestly reignited investor interest in Chinese stocks, despite historically light positioning and a mixed global backdrop, UBS said.
“In our view, the China stock rally has run ahead of a narrow macro recovery and lackluster corporate earnings outlook,” strategists noted.
“Property-related indicators continue to trend downward, which will likely keep weighing on consumer sentiment. And as a result of weak demand, deflationary pressure has so far persisted,” they explained.
Moreover, UBS notes that the downgrade in 2024 consensus earnings growth forecasts may have further to go, adding that the 1Q24 results season is likely to underwhelm market expectations.
They project earnings per share (EPS) growth of 8% for MSCI China in 2024, 4 percentage points lower than consensus. An earnings inflection point will depend on fading key macro headwinds, the investment bank stressed.
Key factors include the stabilization of Chinese property sales and home prices, sustained evidence of broad-based reflation in CPI and PPI signaling fuller economic recovery and corporate capital expenditure, and a wider consumption-led recovery expanding from services to goods.
“In absence of these catalysts, we think Chinese stocks offer limited upside in the near future and we are not confident they can outperform emerging market peers,” said strategists.
“We're also watching increasing trade tensions along with technology restrictions from the US, as these could become more noticeable headwinds as the US election season heats up,” they continued.
Within this, UBS believes investors’ exposure to Chinese stocks should be aligned with strategic allocations. Meanwhile, those in pursuit of tactical opportunities “should consider a barbell-style tilt toward cash-returning defensive SOEs as well as onshore Chinese stocks," strategists advised.