China's Stocks Poised for Rebound as Fed Eases, Analysts Say

As the U.S. Federal Reserve prepares to ease its aggressive interest rate hikes, analysts believe this could be a catalyst for a resurgence in Chinese stocks. The potential shift in monetary policy could create opportunities for investors to capitalize on growth sectors within the Chinese market.

Unlocking China's Equity Potential Through Global Monetary Shifts

Monetary Policy Alignment: A Boon for Chinese Equities

The anticipated move by the U.S. Federal Reserve to ease its interest rate hikes could have a significant impact on Chinese stocks. Analysts suggest that this shift in monetary policy could be a driving force behind a potential rerating of growth sectors within the Chinese markets. According to HSBC, the divergence in interest rates between the U.S. and China has made it relatively straightforward for global institutions to favor U.S. Treasurys over Chinese equities. However, with the Fed's easing, this dynamic could change, potentially unlocking opportunities for investors to capitalize on growth sectors in China.

Earnings Growth: The Key to Unlocking Value

HSBC's analysts emphasize that earnings growth is the crucial factor in determining the performance of Chinese stocks. They believe that growth sectors, such as semiconductors and consumer electronics, which have recorded strong earnings in the first half of 2024, could outperform during the upcoming easing cycle. This suggests that investors should focus on companies with robust financial fundamentals and the ability to deliver consistent earnings growth, rather than solely relying on broader market trends.

Overcoming Valuation Concerns

While Chinese stocks may appear attractively priced from a valuation perspective, global investors have been hesitant to allocate capital to the market. According to Morgan Stanley's chief China strategist, Laura Wang, the business fundamentals and macroeconomic conditions have been the primary drivers for global investors' allocation decisions when it comes to the Chinese equity market. Notably, she observed that Chinese stock valuations have not been positively correlated with U.S. Treasury yields in 2024, suggesting that factors beyond just monetary policy are at play.

Addressing the Deflation Challenge

One of the key challenges facing the Chinese economy is the persistent deflationary pressure. The core consumer price index, which excludes food and energy prices, only gained 0.3% in August from a year ago. Former People's Bank of China governor, Yi Gang, has publicly acknowledged the need to focus on fighting these deflationary pressures, which extend beyond just the real estate sector. This broader economic concern has contributed to the lack of a fundamental catalyst for Chinese equities, as households and businesses remain cautious about spending and investment.

Navigating the Earnings Landscape

While second-quarter earnings in China have improved from the first quarter, the overall picture remains mixed. UBS Investment Bank Research reported that capital expenditures fell by 4% in the first half of the year, the slowest since 2017, with industrials and renewables leading the declines. However, sectors such as internet, consumer, and auto companies have reported relatively better results and earnings forecasts. UBS expects the MSCI China earnings per share to grow by 7% this year, suggesting that investors should be selective in their stock-picking approach.

Potential Beneficiaries of Lower Borrowing Costs

In anticipation of the potential benefits from lower borrowing costs, HSBC has screened for Chinese stocks that could be well-positioned to capitalize on this trend. The analysis focused on mainland Chinese stocks with expected revenue growth of more than 10% this year and a debt-to-asset ratio above 60%. Some of the identified companies include Shenzhen-listed hog producer Muyuan Foods, Shanghai-listed China Southern Airlines, and Hengli Petrochemical, a refinery that is in talks to see Saudi Arabia's Aramco take a 10% stake.Overall, the rebalancing of global monetary policies and the potential easing by the U.S. Federal Reserve could create a favorable environment for Chinese stocks, particularly in growth sectors with strong earnings potential. However, investors should also consider the broader economic challenges and focus on companies with robust fundamentals and the ability to navigate the evolving market landscape.