China's regulatory onslaught across multiple sectors is triggering declines across Asian stock, bond and currency markets. Many investors' confidence about China as a source of stability has been shaken. How should we read recent policy moves? Has the regulatory risk been discounted into asset prices? And what does this mean for investment portfolios? Find answers in our Q&A.
Question #1: Should investors buy, hold or sell China?
A small rebound in the market over the past few days prompted questions from investors if the worst is already behind, and whether it is sensible to add more exposure to Chinese stocks. The answer depends on whether we are debating over a threeweek or three-month view. A number of sectors are trading at depressed valuation levels and look technically oversold, so a brief rally triggered by short covering is possible. Nonetheless, we maintain our view that the earliest time we expect to see a sustained recovery in the market will likely be late this year.
Question #2: Are foreigners or locals a bigger driver of this selloff?
In our view, foreign capitulation is the major reason for this selloff in offshore China equities. There is no foreign trading data available to draw a concrete conclusion. Nonetheless, Southbound outflows were small in recent weeks despite a significant decline in the market. While Southbound flows have been driving market moves in Hong Kong in recent years, we believe foreigners contributed the most to the selling pressure in this current correction.
Question #3: Has the internet sector already bottomed?
Similar to the broader market, we believe the internet sector may range-trade at best and a sustained recovery is to be seen only late this year at its earliest. In fact, we see a high chance that internet stocks may see further downward pressure.
Question #4: What is the future of ADRs and VIE structures?
We believe that the future role of ADRs is at risk, while that for variable interest entity (VIE) structures is still in ques-tion as the regulatory stance is unclear.
Question #5: What other sectors may face regulations next?
The industry coverage has become so wide that it seems impossible to predict which sectors may face scrutiny next. While we agree it is hard to identify the potentially vulnerable sectors, the government seems to be most focused on antitrust/ social equality, data security, basic livelihood, child birth and undesirable social trends.
Question #6: What do you think about electric vehicles (EV) and clean energy?
Notwithstanding the potential for a near-term correction in these sectors, we believe the structural growth stories for EV and clean energy are intact, so we recommend that investors accumulate on pullbacks. Electric vehicles (EV) and clean energy have become the new favourites among investors.
Question #7: What do you think about healthcare in China?
Buying national champions will be the most defensive way to gain exposure to the healthcare theme by keeping the impact of policy changes to a minimum. Healthcare in China is driven by a slew of demographic drivers, including an ageing population, growing disposable income and a higher chance of chronic diseases. However, we agree that it also faces regulatory risks, similar to other sectors.
Question #8: Do recent policies affect Chinese banks?
After seeing the worst of policy pressure over, the sector is a great option for income investors despite its limited poten-tial for capital appreciation. If investors are looking for a “hid-ing place” which may be less vulnerable to potential policy shocks, Chinese banks should have seen their worst in terms of regulatory pressure, in our view.
Question #9: What is your recommended sector allocation in China?
Our allocation recommendation within the China market for H2 2021 follows three axes of thoughts. First, we prefer sectors that have lower policy vulnerability. Second, we prefer post-profit companies over pre-profit companies. Third, we suggest raising defensive exposure.
Question #10: How will China-US relations affect the Chinese market?
The main negative in this area is the increase in diplomatic and international trade policy risk, which may raise the eq-uity risk premium of the Chinese market. The main positive is the rise of import-substitution sectors as a result of the tension. The American consensus view towards China has deteri-orated, as evidenced by various surveys. This limits room for the Biden administration to turn softer on China, even if it benefits the American economy.