China: Are shares cheap? Not necessarily, and challenges to overcome

Chinese stocks are back in fashion. Some strategists recommend emerging equity markets and China for 2023 as the dollar and long US rates drop. For China, the main arguments would be the low valuations of the stock market, the reopening of the economy with the easing of Covid sanitary measures, the priority for the economy, while in the Congress of the Communist Party, Xi Jinping had approved national security as a priority , technological independence and Taiwan, the devaluation of the yuan and the recovery of domestic travel.

Since mid-October, Chinese stocks have recovered some of their arrears. The CSI 300 was up 8.7%, Hang Seng China Enterprises (Hong Kong) 29% and Nasdaq Golden Dragon (US) 52%, while MSCI World was up 6%. Therefore, it is above all Chinese technology that has made great strides.

Regarding PE ratios, we are not convinced they are particularly attractive at 13.6x 2022 for the CSI 300, while the 10-year average is at 12.7x, at 9x for Hang Seng China Enterprises for an average of 8 .4x and the Nasdaq Golden Dragon at 24.8x for an average of 25.5x. Europe looks more attractive with a PE ratio at 11.4x 2023 to the Euro Stoxx 50 with a 10-year average at 13.6x.

The risks are still present: insufficient economic support, the worsening housing crisis, the explosion of Covid infections, the impacts of very tough restrictions on American semiconductor exports to China and the return of tensions around Taiwan.

The recent relaxation of sanitary measures is reflected in an explosion of Covid infections. The result is a tense hospital system and a shortage of drugs. Under popular pressure, the easing was quick and sudden, taking the entire Chinese hospital and medical system by surprise. Three weeks ago, the demand for cold and fever medicine increased tenfold, leading to stockouts. Delivery companies are closing, not because of lockdowns, but because employees are sick. Beijing is particularly affected. In December, economists expect a sharp reduction in economic activity. In November, retail sales were down 5.9% from November 2021 and industrial production was at 2.2%, below estimates of 3.6%. Traffic on social networks, e-commerce platforms and travel reservations was at very low levels.

The US restrictions, followed by the Netherlands (ASML) and Japan, on exports of high-tech semiconductors and equipment used to manufacture semiconductors will hurt China, considering that China would be five years behind schedule. Last week, the US government blacklisted Chinese semiconductor maker YMTC and 21 other artificial intelligence companies. In advanced technologies, China wants to eliminate the barriers between the military and private sectors (Alibaba, Tencent, etc.), validating the great fear of the Americans: that technology only serves the interests of the People’s Liberation Army.

Congress is preparing a new law banning US imports of Chinese products incorporating semiconductors manufactured by YMTC, CXMT and SMIC, and targeting all companies directly or indirectly involved in the People’s Liberation Army. Americans want to break Chinese technological advances for the military, artificial intelligence, surveillance cameras and facial recognition.

To deal with tough US sanctions, China will launch a $143 billion spending plan to shore up the semiconductor industry and become self-sufficient. The Chinese target for full technology independence is 2027. SMIC will then become a powerful competitor to TSMC and GlobalFoundries.

The American restrictions, followed by the allies, will reinforce the dominant position of TSMC and Samsung, but also allow the emergence of alternatives to China in the development of semiconductor production in Vietnam, India and Singapore.

Real estate is a complicated subject. After 30 years of uninterrupted real estate growth, the turnaround, observed since 2021, is brutal and many Chinese find themselves owners of unbuilt homes. No one buys off-plan anymore. Others go on strike to pay their debts. 70% of China’s wealth is in real estate, compared to 60% in France and 38% in the United States. The debt of Evergrande, the largest real estate developer, is equivalent to 2% of Chinese GDP.

Taiwan remains the Communist Party’s obsession. Ten days ago, the Chinese Air Force made a record incursion into Taiwan’s Air Defense Zone (ADIZ) with 21 fighter jets, including 18 nuclear-capable H-6 bombers. China has imposed new import bans on Taiwanese food, drink, alcohol and fishery products. Taiwan’s prime minister accused China of violating international trade rules and discriminating against the island. In its 2023 defense budget, the United States will allocate $10 billion to arm Taiwan. In conclusion, the challenges for China are many, the prospects for China’s economic opening with the relaxation of Covid rules are still uncertain, the consumer is cautious and the real estate crisis is severe. PE indices are in line with historical averages. And trade, technological, financial and geopolitical tensions with the United States make other Asian countries more interesting, such as India and Vietnam.

Heravest SA is an independent investment advisory boutique and investment solutions provider.

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