Greater China equities: pivots, positioning and pace forward
It’s been an eventful year for Greater China stock markets, with domestic and global events triggering broad-based weakness and elevated volatility in Mainland China, Hong Kong, and Taiwan. We describe the three factors that could set the tone for the new year: pivots, positioning, and pace forward.
Greater China equities witnessed widespread weakness during the first three quarters of last year on the back of a hawkish U.S. Federal Reserve (Fed), rising geopolitical tensions, as well as COVID-19-related lockdowns and other restrictions. Taiwan equities were under pressure as weak consumer demand for electronic mobile devices led to reduced production and inventory buildup in the technology supply chain. Toward the fourth quarter of last year, Mainland China introduced supportive measures for the property sector1 and the much-anticipated easing of most COVID-19 restrictions, setting the stage for an impressive rally.2
Next, we detail our thoughts for the 2023 outlook based on recent policy pivots and positioning.
Pivots—essential moves for an economic turnaround
We believe that policy pivots and resets matter the most for Greater China equities.
1 Easing of COVID-19 restrictions
China reopened its border on January 8, 2023, marking the end of a three-year strict-quarantine requirement. Meanwhile, the Hong Kong-China border also reopened.
With the country no longer pursuing its zero-COVID policy, we see a likely revitalization of economic activity (e.g., investment and consumption). This will be crucial for containing logistical disruptions and global inflationary pressures. In our view, Mainland China’s GDP will be recovering from a low base due to earlier COVID-19 lockdowns—2023 GDP is likely to be set at 5% or higher. We also expect the economic recovery to start from the second quarter of 2023, with corporate earnings bottoming out in the first quarter or first half of this year. Thereafter, healthier fundamentals and upward earnings revisions might push the market higher. In the near term, we believe that economic data and fundamentals will remain challenging, and earnings might still face pressure.
2 Central government support for the property sector
In November, the People’s Bank of China (PBoC) and other top regulators jointly announced “three arrows” to provide credit, bond, and equity financing support to the country’s onshore property developers (both public and private developers). Furthermore, on January 5, 2023, the PBoC and the China Banking and Insurance Regulatory Commission jointly announced that the floor on mortgage rates could be lowered or abolished for first-time house buyers in cities where new house sale prices had experienced month-over-month or year-over-year declines for three straight months. We expect Mainland China’s domestic property sales to recover gradually.
3 Better U.S.-China relations
The meeting between Chinese President Xi Jinping and U.S. President Joe Biden at the G20 summit brought about a better relationship between the world’s two largest economies.3 Facilitated by Mainland China’s reopening, U.S. Secretary of State Antony Blinken is scheduled to visit China in early 2023. Should China and the United States resume more bilateral communications, we expect improvements in the market risk premium, which could enhance returns in 2023.
Positioning—reopening plays and secular growth opportunities
Mainland China’s reopening creates some bright spots for Greater China equities. We believe the following sectors will benefit from the reopening:
1 Reopening plays
In the wake of Mainland China’s reopening, the recovery of the service industry should be significant, especially in areas related to travel services and catering. We should see better growth recovery in online travel agencies, considering they’re scalable and less constrained by raw material costs, human resource challenges, and capacity issues. In addition, segments such as online/e-commerce and food, beverage, and catering could also recover significantly, enjoying stronger tailwinds from fewer lockdowns.
Despite the pullback in hotel occupancies across the country in December 2022 due to the worsening COVID-19 situation, we favor leading hotel chain operators with earnings upside potential in the early stages of reopening due to their strong pricing power amid reduced industry supply, operating leverage, and better cost structure (in a post-COVID-19 environment). Domestic hotel chains are clear beneficiaries of the reopening and we expect occupancy rates to improve.
Hotel occupancy in Mainland China
Source: STR, Morgan Stanley Research, as of December 2022.
We have a favorable view of Chinese internet platforms that are exposed to niche areas such as recruitment and property solutions—they could see a stronger rebound after the easing of COVID-19 controls.
Capital spending could be a secondary driver of growth. In the past 18 months, capital spending in Mainland China has declined due to a lack of growth visibility during COVID-19-related lockdowns. We foresee corporates to expand capacity in a bid to meet the pent-up demand that has been unleashed as a result of the reopening. We expect infrastructure investment to lead the recovery cycle and believe that capital expenditure by private enterprises should gradually pick up. We also see opportunities in the construction sector and related segments (e.g., materials) as the recent property rescue package targeted the completion of stalled projects.
2 Technological innovation/localization and manufacturing upgrade
We see technological innovation and localization opportunities in Mainland China, particularly in the semiconductor and software industries. First, electric vehicles (EVs) are the new drivers of the semiconductor industry, and EVs and autonomous driving are boosting demand for chips in cars. Second, there are various types of semiconductor products in cars with unique features that could provide significant localization opportunities in Mainland China:
- System-on-chip (SoC) integrated circuits—combine the central processing unit, the graphic processing unit, memory, input/output ports, and other components on the chip.
- Microcontroller unit—the most critical part of an electrical control unit responsible for infotainment or the powertrain.
- Memory—higher density and bandwidth memory semiconductor chips used for autonomous driving, infotainment, and network connectivity.
- Sensors—high-resolution image sensors used in EVs.
We favor Chinese A-share semiconductor component companies, design houses, and fabrication equipment suppliers that are value chain leaders who stand to benefit from industry growth and localization opportunities.
Key areas for Mainland China’s chipmakers
EVs to boost the demand for chips
Market size of auto semiconductors
Source: Manulife Investment Management, HSBC Qianhai Securities, as of July 2022. The above information may contain projections or other forward-looking statements regarding future events, targets, management discipline, or other expectations. There is no assurance that such events will occur, and the future course may be significantly different from that shown here. EVs refers to electric vehicles; SoC refers to system-on-chip.
In regard to the equipment market, Mainland China registered strong growth of 58.0% on a year-over-year (YoY) basis to US$29.6 billion in 2021. The localization rate of the country’s chip equipment remained low at around 10.0%, which presents ample opportunities for domestic companies to grow.4
In terms of software, we favor companies that are key beneficiaries of rising digitalization across different industry verticals, in particular, leaders in software as a service (SaaS) that could benefit from enterprise digitalization transformation, increased demand from cost savings, and operating efficiencies.
According to the Ministry of Industry and Information Technology, Mainland China’s software industry revenue grew by 9.8% YoY to RMB 6.4 trillion in the first eight months of 2022 despite a COVID-19 resurgence in the country. In addition, SaaS penetration in terms of total information technology (IT) spending in Mainland China is still much lower than that of the United States.5
By segment, IT services and security enjoy faster growth than software products and system software.
On the other hand, Mainland China’s enterprise application SaaS market is expected to grow by 22.0% (projected compound annual growth rate for the 2021–2026 period) driven by an expansion of the public cloud market and rising penetration due to demand for enterprise digital transformation.
With improved software self-sufficiency amid geopolitical tensions, we believe domestic software leaders may also gain market shares from foreign players.
Manufacturing upgrade is another unstoppable trend—automation is a fast-growing industry in Mainland China, riding on the trend of labor replacement owing to rising wages and labor shortage; the rapid expansion of emerging end markets such as consumer electronics, automobiles, batteries, solar/semiconductors; and the ongoing trend of domestic substitution (which drives industry growth). We favor automation component companies that are leaders in the respective components segment with strong research and development and product pipeline, and those with vertical integration capabilities with increasing ability to control costs.
The Chinese government has reiterated the importance of innovation, technological development, and manufacturing upgrades to pursue technology self-sufficiency, serving as long-term tailwinds for the country’s advanced manufacturing industries that are involved in scientific and technological innovation. Mainland China will reportedly provide more than RMB 1 trillion over the next five years to subsidize its semiconductor industry,6 implying a major step toward its self-sufficiency goal. Besides central government support, the industry has also been increasing research and development expenditures.7 In our view, increased capital expenditure will expand manufacturing capacities and advanced manufacturing will play an essential role in localizing supply chains for manufacturing import substitutes.
3 Taiwan’s tech sector
After a market correction in 2022, valuations of some of Taiwan’s leading technology names are, in our view, beginning to look attractive. There are signs that inventory levels in Taiwan’s tech sector are beginning to bottom out (most downstream technology companies in Taiwan have cut their inventory levels in the third and fourth quarters of 2022). Taiwanese semiconductor firms continue to benefit from deglobalization (some U.S. companies are adjusting their supply chains, using only components made outside of Mainland China). Several bright spots are emerging from the Taiwanese tech sector:
- We favor foundries that will likely benefit from Mainland China’s self-sufficiency ambitions after the United States expanded its list of chip export restrictions. Global companies are looking to diversify their factory locations and seeking semiconductors and related parts from China and the United States, as well as other markets. We expect higher demand for semiconductors and capex spending may begin to pick up in the second half of 2023.
- We also favor Taiwanese tech component companies in the server industry that are benefiting from new product pipelines.
- We favor display technology companies benefiting from rising demand for electronic shelf label adoption.
Pace forward—stay active on Mainland China’s recovery momentum
In the past year, the Greater China equity market has been affected by U.S. interest-rate rises and Mainland China’s macro and COVID-19 policies. The valuation of the broader market, using the MSCI China Index as a proxy, now trades at 11.6 times price to earnings (P/E), close to its 10-year historical average.8 Given expectations for the Fed to slow the pace of its rate hikes9 and the consensus view that Mainland China’s economic fundamentals should gradually pick up following more reopening measures, we think Hong Kong equities (including H-shares) could see their P/E multiples rise, led by the valuation re-rating cycle with the potential of outperforming A-shares in the first quarter of this year.
Overall, we’re optimistic that Greater China equities will enter a more constructive stage. While the near-term global macroeconomic outlook remains challenging, we could see an improvement in the underlying fundamentals of Greater China equities and a re-rating of valuations on the back of the reopening. We’re encouraged by the growth opportunities arising from the country’s reopening, technological innovation/localization, a manufacturing upgrade, and Taiwan’s technology sector.
Greater China equity markets 2022 performance2
MSCI China Index (valuation as of December 31, 2022)
Source: Bloomberg, of January 10, 2023.
1 The “three arrows” in November 2022: On November 8, 2022, the National Association of Financial Market Institutional Investors and the PBoC announced an RMB 250 billion funding facility to provide support for private corporate bond financing. On November 21, 2022, the PBoC announced a plan to issue RMB 200 billion in interest-free relending loans to commercial banks to help ensure the delivery of unfinished property projects. On November 28, 2022, the China Securities Regulatory Commission announced the optimization of five measures in equity financing to support property developers. 2 Bloomberg, Manulife Investment Management, as of December 31, 2022. It is not possible to invest directly in an index. All indexes are rebased to 100 where 100=December 31, 2021, except MSCI Taiwan, which is rebased to 100 where 100= January 3, 2022. Past performance is not indicative of future performance. 3 The Straits Times, November 17, 2022. In November, Chinese President Xi Jinping and U.S. President Joe Biden met at the G20 Leaders’ Summit and pledged to work together to manage tensions and avoid conflict. President Xi added that both sides need to find the right direction for the bilateral relationship going forward and elevate the relationship. 4 SEMI Equipment Market Data Subscription, July 2021. 5 Gartner, as of 2021. 6 Reuters, December 13, 2022. 7 According to a white paper published by the China Association for Public Companies, listed advanced manufacturers in Mainland China reported revenue growth of 20.1% YoY, and research and development expenditures increased to RMB 642.59 billion in 2021. 8 Bloomberg, of January 10, 2023. 9 At its December meeting, the Fed raised rates by 50 basis points (bps), which is lower than the 75bps hikes it had implemented at prior meetings. The FOMC’s median projection expects a rate peak of 5.10% in 2023 versus the current level of 4.25% to 4.50%. The November reading of the U.S. Consumer Price Index also indicates easing inflation pressure, rising only 7.1% YoY, which is lower than expected.
A widespread health crisis such as a global pandemic could cause substantial market volatility, exchange-trading suspensions and closures, and affect portfolio performance. For example, the novel coronavirus disease (COVID-19) has resulted in significant disruptions to global business activity. The impact of a health crisis and other epidemics and pandemics that may arise in the future, could affect the global economy in ways that cannot necessarily be foreseen at the present time. A health crisis may exacerbate other preexisting political, soci