Contrarian Investors See a Recovery for Chinese Stocks Despite the Gloom

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China’s President Xi Jinping presided over the Communist Party’s economic meeting in which policymakers cautioned that massive stimulus wasn’t coming.

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Justin Chin/Bloomberg

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China’s President Xi Jinping issued warnings about US ties with Taiwan. China’s policymakers offered no new plans to stabilize China’s slumping property market, and massive stimulus to bolster the economy isn’t forthcoming. But some contrarian investors still see Chinese stocks poised for a recovery—albeit a bumpy one.

Xi and President Joe Biden had a two-plus hour call on Thursday to try to steady the countries’ relationship and made plans to meet in person. But Xi also warned the US should tread carefully in its relationship with Taiwan. The remarks come as tensions flare around a possible trip by House Speaker Nancy Pelosi to Taiwan, the self-ruled democracy that China claims sovereignty over, and Congress continues a bipartisan push to curb China on various fronts.

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With no signs of de-escalation and few indications Chinese policy makers were changing their policy approach to ease China’s economic malaise, Chinese stocks fell on Friday, with the iShares MSCI China exchange-traded fund (MCHI) down almost 3% in early trading to $49.94.

The Politburo, the Communist Party’s top policy-making body, dropped mention of its 5.5% economic growth target for the year that had been aggressive even before Covid lockdowns left the second quarter barely able to eke out any economic growth. Officials cautioned no massive stimulus was forthcoming. And while policy makers vowed to stabilize the turmoil in the property market, they put the responsibility on local governments to get unfinished property completed and to find ways to entice buyers.

The lack of new policy ideas to deal with the economic malaise as confidence in its slumping property market and broader economic activity suggests China could see a weak recovery in the second half, writes Gavekal Research’s Wei He in a note to clients.

Expectations about the pace and shape of a recovery needs to be checked. But even the prospect of a weak recovery has brought out contrarians who note the pervasive pessimism about China and see a decent setup for Chinese stocks in the second half of the year.

That setup is a byproduct of China turning a corner from its abysmal second quarter and getting some stimulus from policy makers as the US and European economies soften with the Federal Reserve and European Central Bank tightening policy to tame inflation.

“That policy divergence is going to be a theme for global investors over the next six months to a year,” says Phillip Wool, managing director of China-focused Rayliant Global Advisors, who sees a favorable setup for domestically-oriented Chinese stocks.

Ironically, China’s reluctance to throw 2008-like mountains of money at its slowdown quiets the alarm for some. Beijing “not panicking” could signal the situation is largely under control, writes Clocktower’s Marko Papic in a note to clients.

GQG Partners chairman and veteran global investor Rajiv Jain also doesn’t see the property market troubles spiraling into a type of 2008 financial crisis, in part because China has the resources to avert a systemic crisis. But the hefty down payments homeowners made on presales of properties—sometimes as much as 60%—should also keep many from walking away from their mortgages and limit the fallout, Jain says. Plus, as prices fall, especially in third and fourth tier cities, it will draw in home buyers that had been priced out, with Jain noting that housing affordability has been a major problem.

Beijing is also intent on stabilizing the situation, even without massive stimulus. China is rolling out infrastructure spending and vowing to get stalled construction completed. State-owned enterprises could absorb losses or take over weaker developers to restart projects, which could help stabilize the near-term problems in property and sentiment, even if it means kicking the can down the road on China’s longer-run debt problems, Jain says .

Rayliant’s Wool favors domestically-oriented mining, industrial and financials geared to the economy turning, getting policy support or a boost as China tries to reduce reliance on foreign suppliers as geopolitical tensions persist.

Less appealing are the big internet stocks. While most of the “acute effects” of that crackdown are expected to ease, Wool sees more turbulence ahead.

Regulators levied the maximum fine possible under China’s data security, personal information protection and network security laws against DiDi Global (DIDIY) earlier this month and applied the rules retroactively, a warning shot for others about the risk of running afoul of regulators and a reminder that the backdrop for these companies is much-changed from before the crackdown.

Lack of clarity around the fate of new videogame licensing approvals for companies like Tencent Holdings (700. HongKong) or even when DiDi can get back on app stores also looms, says Wool.

Investors assessing internet giants like Alibaba Group Holding (BABA) or Tencent, need to recalibrate their view of these businesses. “These aren’t going to be like Amazon and generate 20% growth. That is history. Instead, maybe they grow at 7% to 8%—like a slow growth utility,” Jain says.

That may be an appealing proposition for some bargain hunters, as China more broadly is becoming. Just be sure to have a strong stomach.

Write to Reshma Kapadia at [email protected]


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