Is it time to relook at China?

The U.S markets have undoubtedly been front and centre of investors' attention this year, amid an exuberant bull run and continued interest in the technology sector. Japan too, has been on investors' radar, with the Japanese stock market having had a strong run so far this year.

Amid the attention on the U.S and Japanese markets, Chinese markets have quietly crept up. The Hang Seng Index is up nearly 20% since the start of 2024, reversing a loss of -32.5% in 2023. Meanwhile, the FTSE China 50 Index is up 14% in the same period - a stark contrast to its forgettable perfromance in 2023, when it declined nearly 20%.

What does this mean for investors looking to put money in the world's second largest economy?

Is the worst over for China's economic and political woes? Should investors dip their toes into the China markets, or should they continue to stay on the sidelines?

All in all, investors would do well to start turning their attention back to the Chinese markets and navigate it carefully.

On the political front, there appears to be little political or policy risks, with no planned major meetings of the Politburo for the second quarter, with the Chinese Communist Party's central committee only gathering in July for a key meeting known as a plenum.

Plenums are important events on China's political calendar that require the attendance of all of the party's central committee, comprising 205 members and 171 alternate members with President Xi Jinping at the helm.

This does not mean blindly buying. Investors should take note that China comes back from a long break next Monday. Given the strong rally over the course of the past few weeks, we might very well see investors and institutions do some profit taking before loading up once more for the next bullish leg. And when this happens, investors can get back in, albeit with a prudent approach.

While the saying "bull in the china shop" normally comes with negative conoctations, I would propose that in this market environment, the phrase takes on a whole new different meaning. Let's take a look at the onshore Chinese market and then by extension, its proxy, the Hang Seng Index. But before diving into the present, we need to know what brought the Chinese markets to its current lows.

It's 2022 and while the world has broadly recovered from the Covid pandemic, it has not come out unscathed. Global economies had to battle rising inflation and the US Federal Reserve announced the start of their Quantitative Tightening (QT) phase as a response. Additionally, Russia launched an invasion on Ukraine - the largest invasion since WW2. Stock markets across the board struggled to recover as investors turned terribly risk-off and we see a capital flight to safe havens like the US dollar. With such a backdrop, the world turned its attention to the next biggest superpower in the East, China.

With China and its territories pursuing a "zero-Covid" policy, coupled with the expectation that China was the first country that re-opened its borders at the tail-end of the pandemic. Additionally, with the 20th CCP National Congress held in 2022, President Xi Jinping further cemented and consolidated his power giving the impression that there is political stability within China and it can be depended upon as the superpower of the East.

But nothing could be further from the truth. China's zero-Covid policy faltered. Despite being the first country to open its borders, the harsh resistrctions hampered further growth. Each time it seemed that recovery was on the way, a new cluster would reset the restrictions all over again, making business deals tough to carry out. Concurrently, China's property crisis was also starting to fall like a house of cards, starting with Evergrande's announcement of a possible default back in 2nd half of 2021. Despite best efforts in controlling the property developers' fallout, by mid 2022, the fear contagion then spread to the rest of the other major developers, such as Country Garden, Sunac and Kaisia Group.

By the time we got to 2023, investors started to move their capital elsewhere in search of higher returns, such as the US and Japanese markets. Factors that contributed to this outflow of capital would be poor performance in the Chinese markets since the end of 2021, the lack of confidence in policymakers to prop up the falling market from the start of 2022 coupled with the growing geopolitical tension with the US on various fronts (e.g. Taiwan, semiconductor manufacturing etc).

Fast forward to today, it's 2024 and Chinese markets have held nicely above their Oct 2022 lows. Shown below, the China A50 index futures has climbed higher from January 2024 lows and added +16.50% YTD. Technical indicators are also advocating for a bullish scenario. We are holding above the 21 weeks EMA along with MACD indicator now showing a build up in bullish momentum. Further, A50 price has also closed above the descending trendline resistance.

While there are some opponents out there that would argue that the mainland Chinese market is heavily manipulated, we can then use the Hang Seng Index (HSI) as a proxy, given that it is more exposed to the global markets compared to the onshore A50 index.

From the HSI chart above, it is clear that while the price movements are wider and more volatile, the general structure of the market is similar to the China A50 index. The HSI has also held very nicely above the 2022 lows and bounced higher, gaining +20% YTD. Technical indicators, similar to the A50 index, are also calling for a bullish scenario. HSI is holding above the 21 week EMA and MACD is showing a build up in bullish momentum. Price has also similarly broken and closed decisively above the descending trendline resistance that started in Dec 2022.

In the previous weeks, US and Japan stock markets are starting to see increasing headwinds for different reasons. Further, being positively correlated does not help their case when there is an increase of downside risks ahead.

For the US, there is a concentration risk. A study by Goldman Sachs has found that the concentration in the S&P500 index is currently the highest it has been in decades. The market rises and falls due to a handful of megacap stocks.

While US megacaps have performed well, the bull run will eventually have to take a breather before it continues. And this is what we see with the recent performance.

Over in Japan, reclaiming the lost decades has been impressive but the continued weakness of the Japanese (JPY) continues to weigh on the economy. There are reports now that the weakness of the JPY in terms of market time and space is a hint of a currency crisis. Without any official announcement, there are suspicions that the Japanese government and policymakers have twice intervened in propping up the value of the JPY. Such uncertainties are definitely spooking investors, especially at a time when the BOJ just started to raise rates.

For the above two reasons, investors are now very possibly rotating their capital out of the US and Japanese markets and the next market to focus on would be one that is currently undervalued. And that would be the Chinese markets.

So, back to the phrase "a bull in the China shop"... While investors can expect more upside to the Chinese markets, it isn't going to be a simple straight forward recovery story. Caution is definitely needed to navigate the Chinese markets going forward even in the event of a confirmed recovery. Some risk drivers that could very well halt the 'bull' and bring about a crash would be the following missteps:

Unclear Directions from the Central Government:

Earlier in March 2024, Premier Li Qiang made a bold announcement that the Chinese government was targeting an annual GDP growth target of around 5% for 2024. This comes admist a global high interest rate and high inflation environment. At the same time, observers left with more questions as to how the Chinese government would achieve this. Chinese inflation numbers are lower and industrial prices are also projected to trend lower.

Unresolved Fallout from the Chinese Property Crisis:

The property slump poses the biggest risk to China's growth story. As seen from the past, Evergrande and its peers have managed to drag the Chinese economy down for an extended period. Citizens' confidence are low and many have also taken losses because of failed property projects.

Chinese Bond Market:

Because the recovery in the stock markets is yet to be confirmed, locals are struggling to find ways to invest in the markets to keep pace with inflation and higher prices. After getting burned by stocks and properties, The last remaining option would be to turn to the Chinese government bond. However as demand for bond increases, bond yields would start to fall, making the Chinese bonds an outlier in the global bear market, making it tougher for the PBoC to turn the trend around.