SUMMARY
Two months after COVID-zero policies ended, China’s equity rally is taking a break. Many observers are focusing on the lack of progress in some facets of the economy as risks to the recovery. We believe that structural problems do not need to be resolved this year in order for the recovery to carry through.
- The potential for earnings growth and valuation repair can be realized without addressing every imbalance in China’s economy and society.
- First, there is plenty of evidence of recovery. Lunar New Year tourism saw substantial growth from last year. Mobility indicators suggest urban traffic had already recovered to pre-pandemic levels. Domestic flights had also seen notable recovery, while international flights had just begun. Purchasing managers indices showed strong services recovery, while manufacturing has narrowed declines, though is still teetering at breakeven. Credit growth remained robust.
- There are also some areas of concern. Early mortgage repayments caught some attention, but are small in scale compared with precautionary savings accumulated in 2022. Property sales still lag, but are picking up after the COVID spread and the holiday. Unemployment remains high but is falling, which is a positive direction for markets. Geopolitical tensions will remain a thorny issue, but the recovery appears to be a bigger driver this year.
- Earnings revisions continue to move up, while valuation repair is lagging, even after the strong rally in Nov-Jan. Eight of 10 sectors have valuations below historical mean. We believe investors are likely to position for the next phase of recovery during the current setback.
