Chinese stocks may be poised to climb again, even after gains from an immense rally in September faded. Recent Chinese policy announcements suggest the government is determined to support the stock market at the same time that the outlook for earnings growth is moderately improving, according to Goldman Sachs Research.
Some investors may be hesitant to chase returns after the whipsaw in stock prices, says Goldman Sachs Research’s Kinger Lau, chief China equity strategist. The last few recoveries in China’s equities were short-lived and weren’t accompanied by policy follow-through. But there are signs this cycle could be more enduring.
“History suggests this rally may have more legs, especially if policy pledges and earnings come through,” Lau says.
One of the main reasons Chinese equities may rally is that the government appears determined to have a significant impact — unveiling more than 10 key measures and papers since late September, spanning monetary and fiscal policy and property and equity markets.
China watchers may have suffered from “policy fatigue” in the past year, given that the delivery on policy promises has been perceived as underwhelming, Lau says. The policy announcements from late September may be different. They have not only positively surprised investors, but those efforts have changed the policy narrative.
“The magnitude, breadth, and comprehensiveness of this easing package is arguably the most significant in recent history,” Lau says. It may rival major support packages in the past, notably the A-share (stocks listed in mainland China) rescue plan in 2015. “Investors are getting what they have been hoping for, to a large extent,” he says.
Every RMB 1 trillion of fiscal stimulus that goes to the real economy (and not for debt repayment) should lift China’s real GDP growth by 40 basis points, which in turn would add 2 percentage points to the earnings growth of stocks in China’s main indexes, the MSCI China and the CSI300. The other factor that could also boost earnings is a moderate pickup in consumption demand.
As a result, our analysts raised their price-to-earnings targets, forecasting that MSCI China companies could trade at 12.0x earnings and CSI300 stocks could reach 14.2x earnings (up from 10.3x and 12.8x respectively). This pushes their new 12-month index forecast for the MSCI China to 84 and for the CSI300 to 4600, increases of 27% and 15%, respectively, from their previous 12-month targets. Goldman Sachs Research’s earnings growth forecasts are modestly below consensus for this year and next.
What if the announced policy moves fail to materialize and this market recovery turns out to be another head fake? Lau suggests that Chinese stocks — the second-largest equity market in the world — still have an important role to play for investors.
Chinese stocks are still trading at a valuation discount to other benchmarks. Lau says this shows that some investors remain reluctant to take risks based on long-term Chinese growth. However, he points out that recent indications of policy support should help reduce the risk of most severe downside scenarios, such as an economic hard landing or policy misstep, and therefore boost Chinese stocks.
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