Transcript
Speaker: Welcome to HSBC Global Viewpoint, the podcast series that brings together business leaders and industry experts to explore the latest global insights, trends, and opportunities.
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Speaker: Hello and welcome to Under the Banyan Tree, where we put Asian markets and economics in context.
Speaker: I'm Harold van Linde, head of Asian equity strategy at HSBC.
Speaker: And I'm Frit Neumann, chief Asia economist.
Speaker: On today's show, it's the classic equity strategist versus economist debate.
Speaker: Positive versus negative, glass half full versus glass half empty, with a focus on mainland Chinese equities.
Speaker: Could a long-awaited rally be a reality and what might need to happen for the market to be re-energized?
Speaker: Let's get the conversation started here under the banyan tree.
Speaker: A little context to put things into perspective before we kick off.
Speaker: The Hang Seng China Enterprise Index, which gives us a broad read on mainland Chinese stocks over time, has actually halved since 2021.
Speaker: This year, Consensus is looking for 20% earnings growth in China.
Speaker: But for the first half of the year, that figure came in at a barely 5%.
Speaker: So, Harold, I got to put you on the spot here.
Speaker: And you are an equity strategist who's obviously perennially optimistic.
Speaker: I'm an economist who's perennially pessimistic.
Speaker: I'm happy.
Speaker: Happy I'm sad.
Speaker: That's just a role we play in life.
Speaker: That's right.
Speaker: But here is a question.
Speaker: Chinese equities, right?
Speaker: We've been talking, and I'm going to say we, I mean the market, the whole world is talking about, you know, wow, these equities have fallen in price and they're just bound to, you know, ultimately be a great story for investment.
Speaker: It's the second largest economy in the world.
Speaker: And so we read about, you know, is this an investment opportunity or not?
Speaker: Now, we don't want to get into those details, but...
Speaker: Tell me, what's going on?
Speaker: We have 5% growth in China.
Speaker: Sure, it's worse than before, but if you look at Chinese equities, they just have not done well the last two or three years.
Speaker: Why that pessimism?
Speaker: Well, first of all, people think that the overall economic numbers have something to do with the stock market.
Speaker: It just doesn't.
Speaker: You have growth in an overall economy, but it doesn't mean that all the companies will grow.
Speaker: If more companies come in, there's more competition.
Speaker: Each of the individual companies do worse.
Speaker: But...
Speaker: Yeah, overall, if you put them all together, and that's the numbers that you look at, total production, yeah, that goes up.
Speaker: But the individual companies' profitability is not good.
Speaker: So when China had 10% GDP growth rates, that's some time ago, right?
Speaker: Early 2000s and first decade of this millennium.
Speaker: Actually, earnings growth wasn't necessarily always that fantastic either.
Speaker: Exactly for that, all the competition that came in.
Speaker: So we shouldn't say, hey, stronger economic growth, markets will do well.
Speaker: Okay, I hear you on this.
Speaker: We can say over the cycle, maybe the correlation between economic growth and markets isn't always there.
Speaker: But then if I look at over the last, let's say, 30 years, mid-1990s, if you had invested $100 in a Chinese equity market, how much money would you have today?
Speaker: Not much more than $100.
Speaker: And the economy is multiple times larger.
Speaker: Isn't there a disconnect?
Speaker: I mean, I hear you on a short cycle, but long term?
Speaker: No, you're absolutely right.
Speaker: If we look at Chinese equities and compare them with the S&P 500, if you would have invested $100 in 1994, that's the data that have readily available, you would have made $153 in China.
Speaker: That's not so much, to be honest.
Speaker: The S&P 500 has done much better, over $2,000.
Speaker: But if you look at it from the year 2000, and this illustrates that the starting time is very important.
Speaker: If you would have done it from the year 2000 and invested $100, in Chinese equities, that would now be $654.
Speaker: And the S&P 500, only $597.
Speaker: So as the optimist, you stick by this story that it's just, you know, obviously the correlation isn't there and it's really about corporate earnings.
Speaker: But then the market is really suggesting at the moment that these corporate earnings aren't coming through, that there is not this big earnings growth.
Speaker: What explains in your view that we're not seeing then the earnings come through?
Speaker: I mean, from an ex-economist, I could tell you that nominal GDP growth is down, and that's probably one of these drivers.
Speaker: But from a bottom-up perspective, why are the earnings coming through that the market is hoping for?
Speaker: No, the problem is competition.
Speaker: In nearly all sectors in China, there is intense competition.
Speaker: You have a lot of electric vehicles, they're exporting, right?
Speaker: But you have the same, of course, in the property sector.
Speaker: You have the same in the consumer sector.
Speaker: There's a lot of industries where there's a lot of competition between the companies.
Speaker: So what that means, they have to lower their prices.
Speaker: So even though the volumes might be at times okay, the amount of revenue, the money that comes into their pockets is actually limited because the margins are under pressure.
Speaker: That's a problem.
Speaker: I completely acknowledge that.
Speaker: But that's something that we also know.
Speaker: That's been going on for quite a few years.
Speaker: And we see now that in certain industries, companies are responding.
Speaker: You see certain companies saying, listen, if I continue to lose money on every product that I sell or every electric vehicle that I sell, I'm going to just simply close shop.
Speaker: So we see consolidation starting to take place.
Speaker: in China as well.
Speaker: So you see already evidence of restructuring within China at the bottom-up level.
Speaker: Absolutely.
Speaker: That companies are merging, that they're closing shop just to rebuild those profit margins.
Speaker: I'll give you a couple of examples.
Speaker: We've had very large property developers leave the market by force.
Speaker: They had to close down.
Speaker: there are now fewer property developers.
Speaker: You could say the same, for example, in a few other industries.
Speaker: There's just been announced a few days ago a large merger in the brokerage industry between two large brokerage institutes.
Speaker: We see this in the EV sector, where many smaller companies have simply closed shop.
Speaker: We know that there were 70 producers about a year ago, and I believe it's about 15 now or something like that.
Speaker: So there's 20 who said, listen, I'm losing money on every car that I sell.
Speaker: I'm just going to stop it here.
Speaker: So evidence of restructuring at the micro level.
Speaker: But then I think there's one elephant in the room which we need to talk about as well, which is geopolitics.
Speaker: Right.
Speaker: And usually when we think about an emerging market, which China still is technically, of course, it's
Speaker: much larger, given the size, it's silly to talk about it.
Speaker: But generally, when you think about emerging market equities, foreign investing, foreign investor buying and selling is obviously quite important.
Speaker: Now, given geopolitical tensions, we've seen foreigners not being as willing to take large exposure.
Speaker: I mean, it may
Speaker: Maybe many reasons, but that's probably one of the reasons.
Speaker: But does that really matter in the Chinese context?
Speaker: Do you need American investors to come into China to drive the market?
Speaker: Do you need Japanese and German investors to buy Chinese equities for the market to fire up again?
Speaker: Or is there enough domestic firepower, if you will, to sustain a rally or a comeback in the market?
Speaker: Well, you're helping me out here, Fred.
Speaker: So I'm glad you see it from the positive and the optimistic side here.
Speaker: But you're right.
Speaker: There is domestic firepower.
Speaker: Do we need foreign investors?
Speaker: Yes.
Speaker: And we know from public statements that certain pension funds in the U.S. have said we will not invest as much anymore in China for the reasons that you mentioned, right?
Speaker: So that's fine.
Speaker: And that has been an issue, I would say, that was really last calendar year that it looked like a lot of them were
Speaker: really reducing the China exposure.
Speaker: And the Chinese market didn't perform very well in the back of that.
Speaker: But does Asia still need offshore money?
Speaker: Offshore, I mean outside of Asia.
Speaker: The largest funds that invest in Asia are now pension funds either in China, in Korea or in Singapore.
Speaker: So there's a lot of regional money around that can probably carry these markets.
Speaker: And I'll give you very nice statistics.
Speaker: The amount of cash in time deposits in Hong Kong is over 1 trillion.
Speaker: I'm going to repeat that because it's with a T. Maybe you didn't hear it.
Speaker: 1 trillion US dollars.
Speaker: 1.2 if I'm not mistaken.
Speaker: In Singapore, it's over 500 billion.
Speaker: So if you add them together, you're getting something that's not far off.
Speaker: 2 trillion US dollars.
Speaker: That is a lot of money.
Speaker: And I can understand people have money in deposits.
Speaker: They say, well, I don't know where to invest.
Speaker: The property sector is not doing well and the equity market is not doing well.
Speaker: So what have they done?
Speaker: They've put in a time deposit and they're rolling it sometimes over into the bonds funds.
Speaker: And they don't really get a lot of money there either, right?
Speaker: But if they feel that there is a bit of confidence coming back that they say we should be maybe actually put a little bit of money into equities, you're talking about billions of dollars suddenly that comes available.
Speaker: So that's something we need to keep in mind.
Speaker: See, and this is the if, if, if.
Speaker: And we're going to dwell into those ifs in a second.
Speaker: I think this is a great time to take a quick break.
Speaker: And when we come back, I'm going to push Harold a little bit more on those ifs because we've been waiting for that rally for quite some time.
Speaker: Well, bring it on.
Speaker: Well, welcome back from the short break.
Speaker: Harold, you mentioned just before the break that, look, there's a lot of liquidity sitting there on the sidelines.
Speaker: You mentioned Hong Kong and Singapore, nearly $2 trillion in liquidity in deposit accounts.
Speaker: Mainland China, similar story.
Speaker: Enormous amounts of liquidity that people put in their banks instead of investing in the equity market or the real estate market.
Speaker: Now, this is potentially bullish for an equity investor.
Speaker: As an economist, I would say, well, this can last for many, many years.
Speaker: Just think of Japan.
Speaker: People put their money in the bank, didn't want to buy equities.
Speaker: And so who's to say that they will not continue to invest their money in bank deposits?
Speaker: What do you think would be a catalyst to really get people off their backs?
Speaker: Yeah.
Speaker: Now, there's a couple of, I would say catalyst is a very difficult word because I think there's a couple of factors that might help them persuade, put money into equities.
Speaker: And each of these factors are not big enough individually to do so, but maybe combined over time this happens.
Speaker: Now, first of all, you put it in a bank deposit, you get something like two, two and a half percent.
Speaker: If you put it in the equity markets and you assume, and now it's a big assumption, that the market doesn't go anywhere, in terms of dividends and share by back yield, you get over 5% this year.
Speaker: So you already get double if the market doesn't go anywhere.
Speaker: Now, if you think that the market will fall 10%, that's nice.
Speaker: You get 5% in dividends.
Speaker: But if it goes down 10%, you're losing anyway 5%, right?
Speaker: So that is quite supportive already.
Speaker: But a key factor that also will help with confidence is if people feel that the property sector is not as much of a drag anymore to the overall economy, that maybe, therefore, if that doesn't drag, maybe the drag on other asset classes is not so big, and therefore, hey, I'm willing to take that risk.
Speaker: The money is there, but we need to see if they're willing to take a bit more risk.
Speaker: And property might play a key role in there.
Speaker: So we see the property market potentially stabilizing confidence.
Speaker: You talk about higher underlying returns in the equity market relative to deposits.
Speaker: Of course, as an economist, I would say, well, there's still a risk attached to it.
Speaker: So, you know, if you're risk averse, you need a lot more incremental return to justify that.
Speaker: But let me push a little bit on the Japan example.
Speaker: You know, economists have written a lot about Japan versus China and where the parallels lie and those parallels often overstated.
Speaker: But nevertheless, put the economics aside, because apparently it doesn't matter for stock markets anyway, it's a claim.
Speaker: But, you know, the Japanese market hasn't gone anywhere for many, many years.
Speaker: It's only the last couple of years it really started to fly again.
Speaker: Why should I have faith that maybe in China we're not looking at 20 years of the market going sideways?
Speaker: From an equity market perspective, where does the difference lie in the Japanese equity market from 30 years ago and the Chinese market today?
Speaker: Now, first of all, if you go to the end of 1989, the Japanese equity market was the biggest market in the world.
Speaker: Pretty much it was as big as almost all other stock markets together.
Speaker: It was trading at incredible high multiples.
Speaker: I think the comparison with Japan and China now is definitely not appropriate.
Speaker: It's more like almost another market like India where multiples are very high.
Speaker: Chinese multiples are really, really low.
Speaker: So I think China maybe should be more compared with Japan 2012 or 2013.
Speaker: At that time, you had reform coming through.
Speaker: Abinomics, you guys have talked about it a lot.
Speaker: He says, I want corporate reform taking place.
Speaker: And there was a lot of kind of feeling that, ah, that's not going to happen in Japan.
Speaker: And initially that didn't really take place.
Speaker: But over the years thereafter, the Japanese companies started to pay more dividends.
Speaker: They started to do more share buybacks.
Speaker: We've seen a bit of restructuring.
Speaker: Some of them left industries.
Speaker: not too dissimilar to what we see now.
Speaker: And the Japanese equity market actually was ticking up very slowly.
Speaker: It didn't almost feel as if it was going up, but it was slowly ticking up.
Speaker: Chinese markets up 5%, 6%, 7% year to date.
Speaker: So it might well be ticking up.
Speaker: And then suddenly by, what was it, 2019, 2020, the market realized, hey, Japanese equities, there's a lot going on here.
Speaker: And suddenly that market rallied.
Speaker: And there was also a week again and these sort of things.
Speaker: So that would imply we'd have to wait another eight years in China before we see that real bank.
Speaker: No, you wanted to buy in 2012 and then stick with it.
Speaker: Now, last question, Harold.
Speaker: And, you know, your points are all well taken.
Speaker: I, as an economist, I humbly withdraw into my dismal world of just analyzing CPIs and growth.
Speaker: But give us an idea, you talked about multiples, and of course what you mean with this is how expensive is the market?
Speaker: For example, the famous P-E ratio, which compares the price of a share relative to the earnings that that share generates.
Speaker: That company generates, yeah.
Speaker: And so give us a sense of how expensive the market is based on these particular ratios.
Speaker: Now, keeping in mind that there's not always a good guide to investment, but just so we have a sense of where does the market rank at the moment?
Speaker: Is it super cheap relative to other markets, both historically and currently?
Speaker: How does it rank relative to its own history?
Speaker: How does the Chinese market look at that?
Speaker: So you can't base your investment, you're rightly saying, just on a PE.
Speaker: If I tell you I've got a car to sell, you don't know what car, it costs you a thousand US dollars, you might say, well, that's really cheap, until you see the car.
Speaker: And then you say, I don't want that car, right?
Speaker: So you have to look at the product itself as well and relate that then to the price.
Speaker: So we're just looking at the PE ratio.
Speaker: China trades it about eight to nine times.
Speaker: Now, put this in context.
Speaker: A couple of years ago, the China internet names, for example, they were trading at 35 times.
Speaker: That's substantially higher.
Speaker: There are stocks in India that trade over 70 times.
Speaker: And there's not just small stocks, but these are regular bigger companies.
Speaker: They're almost 10 times more expensive.
Speaker: So the valuation of the Chinese market, actually, I hardly talk with clients about this because it is just assumed that it is not expensive.
Speaker: The question is, like this car, what do I get for that?
Speaker: And most people are still in your camp and say, well, you know, I don't get a lot of growth and there's a lot of uncertainty on many fronts.
Speaker: And I completely get that.
Speaker: But I also think, as I just mentioned, that there is a lot of cash on the sideline.
Speaker: There is restructuring taking place.
Speaker: There are companies in China are paying our dividends, making themselves more interesting to invest in.
Speaker: So you can see that the market could respond quite quickly to a small reallocation of all their cash that is waiting on the sideline.
Speaker: And of course, that is if confidence improves, which brings it back to the big if, if, if.
Speaker: Yeah, but this is my key point.
Speaker: I think there is not one if.
Speaker: So I'm not saying, hey, property needs to recover of this.
Speaker: But there are many small ifs.
Speaker: Property could recover.
Speaker: Cash could be reallocated.
Speaker: Dividend payments could even go higher.
Speaker: We see consolidation in industries that might create, in certain industries, a bit of better earnings prospects.
Speaker: And all of these things will maybe come together at some point in time.
Speaker: That could shift that sentiment, just like in Japan.
Speaker: And then before you know it, it's actually ticking in a completely different direction.
Speaker: That's what I try to highlight to people.
Speaker: So there you have it, ladies and gentlemen.
Speaker: It's not one big if.
Speaker: It's an if, if, if, if in China nowadays.
Speaker: Thank you, Harold, for defending the market and your profession as an equity strategist.
Speaker: Always half glass full.
Speaker: So from the dismal scientist colleagues, we'll take your advice.
Speaker: And I guess we'll have to look at China's economy in maybe slightly more... In a slightly different way.
Speaker: Yeah, but at least you have a different way of looking at it in a more optimistic way.
Speaker: That makes you much happier as well, Fred.
Speaker: And that's a wrap for another week here on The Domain Tree.
Speaker: Many thanks for joining us, and we'll talk to you again soon.
Speaker: In the meantime, check out my co-host's report on why mainland Chinese stocks could indeed take a positive turn if the stars align.
Speaker: It's called The Flying Dutchman, What Can Go Right for Chinese Equities.
Speaker: Take care, and we'll be back again soon.
Speaker: Thank you for joining us at HSBC Global Viewpoint.
Speaker: We hope you enjoyed the discussion.
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