17 February 2025
We find the renewed enthusiasm for Chinese equities rather ironic given the extreme pessimism in consensus beliefs this time last year. We recall more than one “famous” investment bank declaring China as “un-investible” in 2024. To be fair, we have also argued for many years that China’s structural debt and growth challenges are legitimate and a genuine constraint on the capacity of policymakers to respond with a 2008-style “whatever-it-takes” stimulus.
The fervour in Chinese equities is concentrated in Chinese tech (+31% since the 10th of January). The prevailing bias or narrative clearly shifted from “China is nowhere in AI” to “maybe China has a competitive edge in AI” post the Deep Seek announcement in January. As we noted last week, Our conclusions after Deep Seek are 1) AI gets cheaper, 2) AI requires less power than previously thought, 3) AI proliferates faster, 4) AI winners aren’t who we thought and 5) existing capital spending outlays might be very wrong. The good news for now on US mega-cap tech is that companies have largely reconfirmed capital spending guidance post results. On the negative side for US equities, elevated valuation and limited risk compensation is a challenge if AI does not deliver returns to meet investor expectations.
While there has been a profound and rapid shift in consensus beliefs on Chinese technology stocks, the good news is that valuations and positioning remain modest. From a pure price perspective, the Hang Seng Tech index remains 50% below the February 2021 high and well below the NASDAQ performance over the period since (chart 1). Short interest remains elevated in the major Chinese ETFs listed in the United States (see FXI). Our own Asia tech basket (which includes Korea and Taiwan names) trades at 12 times forward earnings, net cash on balance sheet and FY+1 EPS +25%. The big picture point is that while there has been a rapid shift in price and consensus beliefs over the past few weeks there is considerable potential for a further short squeeze given inexpensive valuations, capacity for share buyacks and the improvement in earnings.
Chart 1
While we are conscious that previous phases of enthusiasm have ended in disappointment, there has been a clear shift in trend, supported by genuine fundamentals – growth in cash-on-cash returns, buybacks, and valuation. Or as one of our mentors would have said, valuation is starting to bite or be appreciated by investors. We would also add that most large institutional allocators remain underweight emerging markets and especially China.
As we noted above, the renewed enthusiasm for Chinese equities has been concentrated in the tech sector. In contrast, the outlook for the broader economy remains challenging. China’s macro problem is not monetary, it is fiscal. The key challenge is insufficient domestic demand and confidence. From our perch, the solution will require structural reform of the social safety net and a much larger central government fiscal impulse.
In contrast, more liquidity support, higher equity prices and monetary measures will only help at the margin. Real estate prices and activity are weak and will likely remain soft while the credit impulse (rate of change in credit growth) is contracting. That is a key reason why we prefer the large tech and platform stocks that are net cash on balance sheet.
The final point to note for emerging markets and China is the tactical correction in the US dollar. The JP Morgan EM currency index has rallied by 4.3% from the January low after falling by 8% since the Fed rate cut in September. The appreciation of the US dollar since September was caused by a reflexive (self-reinforcing) rise in US short rate, inflation expectations and Treasury yields in anticipation of the Trump policy agenda. However, by January that risk was probably well priced and appreciated. Some elements of the Administration’s policy agenda have also not been as bad as feared for the global growth and inflation trade off. Peace talks in Ukraine and the Middle East might also reduce the dollar’s haven demand. A reversal in US dollar strength, given crowded long positioning and beliefs would likely be helpful for emerging markets and China.
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