25 February 2025
Controversial opinion: the Fast and the Furious movie franchise improved considerably by the tenth sequel. Perhaps the Chinese equity market will also see an end to the secular bear market following the tenth policy iteration? As we noted last week, there has been a profound and rapid shift in consensus beliefs on Chinese equities over the past few weeks. Renewed enthusiasm has been concentrated in Chinese tech, +73% from the August low last year and Alibaba +82% over the same period and +64% year to date. However, MSCI China is also up by 40% over the past year.
The irony of the powerful and impulsive rally in Chinese equities is not lost on us. This time last year, the prevailing bias and consensus positioning was extremely bearish and underexposed to Chinese equities. Indeed, many investors argued that China was not investable. The good news for China bulls is that flows, positioning by large allocators and short interest in ETFs like FXI suggest that investors remain short or underweight. From a fundamental standpoint, MSCI China still trades at only 12 times forward earnings. Similarly, key stocks like Alibaba trade at inexpensive valuations. Of course, the big picture question is whether there has been a sustainable improvement in profits or returns on equity?
While that is a challenging question for the broader market, Alibaba printed one of its best results in years on Friday (cloud, AI capital expenditure and core commerce) leading to material upgrades by the sell-side. A conservative valuation could warrant a further 50% upside based on valuation of the core business and the capacity to buy back shares out of cash. There is similar potential for some of BABA’s peers. Of course, as we noted above, the sector has already rallied materially from the August low last year and the record low in October 2022.
On the broader market, we have argued for several years that the structural debt and growth challenges in China were legitimate and a genuine constraint on trend returns on equity. The good news is that they were also widely appreciated.
The bear market in real estate prices and construction (or the macro correlated sectors) has been underway for several years. Concurrently, the regulatory crackdown on the technology sector commenced in October 2020. That contributed to a 60-70% bear market in the sector. However, by October 2022, the regulatory crackdown and broader deflation in the economy was well priced. More recently, investors have also demanded a higher risk premium for “tariff” risk from the new US administration and dollar strength.
We agree with Morgan Stanley that the additional positive developments over the past week were the pivotal regulatory shift from “rectification to revitalization” and a more favourable approach toward the private sector. Moreover, talks to end the conflict in Europe, positive incremental news flow on tariffs and the potential for China in technology are encouraging. On China macro and growth momentum, a larger fiscal thrust is still missing (that is evident in the anaemic credit impulse in this cycle). On the positive side, the way spot iron ore and stocks levered to Chinese growth are trading, suggests that this might be on the way at the NPC announcement in early March (chart 1).
Chart 1
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