Transcript
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Speaker: Welcome to Under the Banyan Tree, where we put Asian markets and economics in context.
Speaker: I'm Harold van der Linde, head of Asian equity strategy at HSBC here in Hong Kong.
Speaker: And I'm Fred Newman, chief Asia economist.
Speaker: We're back recording together in person for the first time in a few weeks.
Speaker: And we wanted to talk about China because the two areas we study are pulling us in very different directions.
Speaker: That's absolutely right, Fred.
Speaker: On the one hand, your team has lowered economic growth forecasts for China, but at the same time, for those of us in the equities world, we actually see significant earnings upgrades coming through from the Chinese corporates.
Speaker: How does that all add up?
Speaker: We're about to tell you right here on The Banyan Tree.
Speaker: Let's start with some numbers to back up what we were just saying in the intro.
Speaker: Recently, my team and I revised down our estimates for Chinese growth for the year to 5.3% from 6.3% off the back of disappointing data following the post-COVID reopening.
Speaker: But at the same time, in my world, and that's the equities, consensus earnings, so that's all the earnings generated by hundreds of analysts across the street, they've actually seen numbers going from 20% for Chinese companies this year, much higher.
Speaker: It's about 27 at the moment.
Speaker: So Fred, let's kick off with the macro side.
Speaker: What's happening in China?
Speaker: Well, the economy is slowing, no doubt about it.
Speaker: Second quarter numbers have been, again, progressively softer, actually, between April and June.
Speaker: And that was after a fairly strong start in the first quarter.
Speaker: So it looks as if the economy is now, having peaked already in the cycle, starting to slow.
Speaker: And it's starting to slow really across sectors.
Speaker: We see the housing market slow.
Speaker: We see consumer spending a bit wobblier.
Speaker: Of course, the export side is not happening.
Speaker: And even infrastructure spending is slowing at this point.
Speaker: And that's why you see policymakers bringing in stabilization measures.
Speaker: It's probably too much to call them stimulus measures, but they're stabilization measures they're rolling out.
Speaker: But nevertheless, we actually recently downgraded GDP growth for this year, just given how weak the data was recently.
Speaker: But, you know, the economic outlook is challenging.
Speaker: That, of course, doesn't always mean that the equity market follows what the economist or the economics is indicating.
Speaker: So how has the equity market been?
Speaker: And obviously, the headlines are not terribly encouraging, are they?
Speaker: No, we had a good start to the year, but after, say, mid-February, the realization started to come in that, yes, actually, maybe that momentum is slowing, just as what you mentioned.
Speaker: Since then, we've seen the equity market slide.
Speaker: I wouldn't say that it's really collapsed in the sense that we're back to the levels we had last year, but it's slightly lower.
Speaker: There's been a bit of a distinction between what happened in Shanghai and Hong Kong because the dynamics between these markets differ a bit.
Speaker: In Hong Kong, global...
Speaker: Factors such as global bond yields and what happens with US interest rates is important.
Speaker: That is much less so in Shanghai.
Speaker: But the interesting thing is that if I look at some of the underlying economic indicators that we look at such as earnings growth, they've actually hold up reasonably well.
Speaker: And that might be one of the reasons why it hasn't slid so much as if you would look at the macro numbers.
Speaker: So let's unpack that a little bit.
Speaker: So if I look at the housing market, which is so important for the Chinese economy still, a lot of the weakness in the overall economy can be traced to a still wobbly housing market.
Speaker: In fact, we see housing sales slide again after having peaked around March.
Speaker: They got progressively worse in April, May, and June.
Speaker: We see new housing construction being very weak.
Speaker: And of course, the weaker housing market is weighing on consumer spending, but it's also weighing on infrastructure spending because, of course, local governments need the revenue from there.
Speaker: It's weighing on heavy industry, less steel demand, for example, coming through.
Speaker: So it's connected to most of the economy.
Speaker: So really, it's one of the key kind of
Speaker: Drivers.
Speaker: Drivers or kind of weights around the Chinese economy that kind of hold down the economy.
Speaker: But if you look at earnings in the economy, where is actually better earnings coming through?
Speaker: This is funny, Fred, because a different picture then suddenly emerges.
Speaker: So real estate earnings are pretty strong.
Speaker: And actually, healthcare earnings and consumer sectors are showing reasonably strong earnings growth as well.
Speaker: The question is why, and I think this is a difference between the micro and equities and the macro that you talk about.
Speaker: Because you're absolutely right, the housing sales, they don't look really good.
Speaker: Now, imagine you're a buyer of a Chinese property.
Speaker: There are buyers, of course, of property in China.
Speaker: Do you want to buy from any property developer that if it goes bankrupt, you will probably have serious consequences as problems as well?
Speaker: Or do you say, if I buy something, I'm going to stick with those developers that you know have a reputation of running their business, very strong, good cash flow, strong balance sheets.
Speaker: those will be the survivors.
Speaker: Those companies will still be around in five or ten years' time.
Speaker: And even though the location might not be perfect for you, it is from those companies that you want to buy a property from.
Speaker: How about you understand that a little bit, Harold?
Speaker: Because you said overall earnings in China are actually quite healthy.
Speaker: Earnings growth is quite strong.
Speaker: And yet the headline GDP numbers are looking more challenging.
Speaker: And then you said in some sectors, you essentially have some companies that still
Speaker: do better than others.
Speaker: But from an aggregate perspective, is the higher earnings then accounted for by the fact that we have actually some of the weaker companies exit the index and therefore we have higher earnings come through for the survivors, if you will?
Speaker: Or are the profits so strong among the stronger companies that offset the weaker earnings than the other companies?
Speaker: Well, it's a bit of both, to be honest.
Speaker: So first of all, I only look at a small part of China.
Speaker: You look at the whole of China.
Speaker: And it turns out that that smaller part of China is simply doing better than the whole.
Speaker: So that's one thing.
Speaker: The earnings numbers in China this year...
Speaker: actually look pretty strong.
Speaker: And if you compare it with what those numbers were three months ago, it's actually gone up right at the time when you as an economist were downgrading your GDP forecast.
Speaker: So there's clearly a dichotomy, a disjunction here.
Speaker: And I think a lot of it can be explained by first that we only look at a small part of the overall economy.
Speaker: And that part tends to be the better quality companies that now really are consolidating those industries.
Speaker: And maybe this is becoming one of the bigger themes over the next couple of years that, yes, the macro doesn't look so good, but the micro actually starts to improve.
Speaker: Yeah, and I think it's worth reiterating that point.
Speaker: If you look at one widely cited number out of China that we see cited in newspapers, for example, is national profit growth.
Speaker: Flana actually publishes a number, and profit growth overall has actually declined quite significantly because there's still smaller enterprises in China.
Speaker: They're suffering from weaker growth, and of course, that is reflected in the aggregate number, and that poses challenges for
Speaker: Bank lending, for example, poses challenges for employment growth.
Speaker: And so that's where some of the discotomy comes in, because really the equity market represents a smaller, high-quality part of the economy, and there the profit dynamics may be different.
Speaker: Now, one question, though, is if the earnings are not so bad for listed companies, why is then the index itself not
Speaker: you know, performing better.
Speaker: Because if we look at performance of the overall market, surely it's fair to say that China has lagged so far.
Speaker: That's absolutely right.
Speaker: So first of all, earnings are not the only driver, right?
Speaker: It is the confidence in those earnings, for example, that's a matter as well.
Speaker: Also, of course, what happens with discount rates and interest rates and these sort of things is really important, in particular for the Hong Kong listed companies I mentioned earlier on.
Speaker: But we need to see that confidence in the earnings coming through and maybe an understanding that there might be a disjunction.
Speaker: Yeah, and remember when China's economy was going gangbusters about 10 years ago and had really high economic growth rates, the stock market didn't perform so well because it was everybody wanted to be in China and every CEO of every company in the world needed to have a China strategy.
Speaker: So it was highly competitive and this maybe the opposite is taking place now.
Speaker: Nobody...
Speaker: really wants to be there.
Speaker: I mean, companies have a China plus one strategy, the private sector is not really investing.
Speaker: And therefore, you get suddenly a very different industry dynamic at play, consolidation.
Speaker: And in terms of, do we have other examples of countries where you see slowing economic growth?
Speaker: but you see actually an improvement in earnings, partly because of the micro developments you're describing.
Speaker: So do we have other examples across Asia where you have economies slow and you see the earnings improve?
Speaker: Yes, I mean, there's two examples that come to mind.
Speaker: I think there's probably more examples, but let's focus on two in almost the extremes of the region.
Speaker: First of all, Korea.
Speaker: The DRAM sector, so the memory sector, the memory chips, if you have your phone on and you turn it on again, it gets the same website again, that's a memory chip.
Speaker: That was highly competitive, say from 2005 to 2012, 2013 or so.
Speaker: Margins were very low.
Speaker: There was a price war going on.
Speaker: People were losing money.
Speaker: And some of the companies said, I'm not going to expand anymore.
Speaker: I'm going to try to diversify my business into something else and not really invest in memory anymore.
Speaker: But the two or three companies that did or were already quite big,
Speaker: They stayed with it and they have benefited from this.
Speaker: And for example, the DRAM sector has therefore consolidated and has performed pretty well over the last, say, 10 years, despite the fact that the Korean economy, or maybe even the global economy, has not done what it would suggest otherwise.
Speaker: So that's an example.
Speaker: A reverse, you could also say, is in India.
Speaker: The India economy was growing really strong from, say, 2006 to 2000, even till now.
Speaker: But from 2006 to 2016 or 17, the Indian telcom industry, the sector, did not perform very well.
Speaker: Now, you would think, why not?
Speaker: Because Indians were buying mobile phones.
Speaker: They were signing up for better packages.
Speaker: They went from voice to data so the companies could make more money out of it.
Speaker: And that's all true.
Speaker: But everybody wanted to be in Indian telcoms.
Speaker: And by 2016, a new player came in to such an extent you got a price war that some people just said, I'm leaving, I'm out.
Speaker: And the market suddenly collapsed almost to three key players.
Speaker: And these stocks have gone up about four times, three to four times over the last five years because the same pie, the pie is growing still rapidly.
Speaker: slowly, but the same pie was suddenly carved up not by six or seven players, but by three large players.
Speaker: D-REM had the same.
Speaker: Maybe the EV sector in China is a nice example where this is starting to take place and maybe real estate as well.
Speaker: That might explain that differential between the macro and the macro.
Speaker: Really, I hate to admit this, Harold, but I think you're suggesting that economic growth is not destiny when it comes to equity markets.
Speaker: And as an economist, I take a bit of offensive.
Speaker: Yeah, absolutely.
Speaker: I almost should tell people that they should not listen to economists anymore when it comes to China.
Speaker: No, but joking aside, of course, we need to understand what the bigger picture is.
Speaker: And we need to listen to economists also for what happens with interest rates and these sort of things.
Speaker: But we also need to learn to distinguish that the industry dynamics can be extremely important.
Speaker: So we need to make a step deeper.
Speaker: And that maybe at this junction, in particular in China, that that could be a very different kind of situation.
Speaker: story unfolding that allows us to understand, hey, why are the earnings up while the economic growth rates are down?
Speaker: Well, you heard it here, ladies and gentlemen, we have Harold van der Linde suggesting that you still, there's some worth listening to economists every once in a while.
Speaker: But don't forget to listen to the strategists as well.
Speaker: So I think that's an extremely important point to make here, that we do have Chinese economic growth slowing, but
Speaker: sometimes the headlines obscure some of the more positive stories that are occurring in terms of individual sectors, profit generation, etc.
Speaker: And so we're perhaps in a period now where markets are driven by extreme macro considerations.
Speaker: And sometimes in a cycle, the micro stories get buried in these headlines.
Speaker: And ultimately, the market then tends to kind of
Speaker: sort through the rubble and then look at the micro stories again, but that's maybe a bit further out.
Speaker: No, no, and this is, I think, one of the advantages of the Chinese market that is so big that you can actually say, okay, I'm going to ignore these sections of the market.
Speaker: I'm going to focus on this.
Speaker: And those sections are still big enough.
Speaker: They're bigger than some of the other stock markets that are listed in the rest of the region, right?
Speaker: So that you can actually do this in China.
Speaker: You can dive a little bit deeper.
Speaker: So Harold, we're finally back together recording our Under the Banyan Tree together after a few weeks on the road.
Speaker: And where did the journeys take you?
Speaker: Well, actually, quite a few places.
Speaker: I went first to the Netherlands, see family and my son.
Speaker: I went to Norway, which I think is the Japan of Europe, meticulously kept and a very beautiful place.
Speaker: Clear blue skies, turns out to be the Mediterranean as well.
Speaker: After Europe, I went to India to see clients and then I took a trip and this was really fascinating through the southern part of India, Tamil Nadu, for about say almost a week.
Speaker: And it's a beautiful place.
Speaker: I went to see temples because that's what I'm really interested in these days.
Speaker: But also the infrastructure, you can see that India is building infrastructure.
Speaker: So sometimes we had a road that meandered through the paddy fields and then suddenly you're going to a highway for...
Speaker: half an hour maybe and then suddenly the highway stops and people are literally there with shovels and pickets working on it and you go on some dirt road to the next and then through the pedifields again and then 100 kilometers later you're back on the highway so really that's an infrastructure in progress kind of story that you could really see is really fascinating and yeah move 10 years forward and you can see that all of that is in place and that allows for growth in India right
Speaker: When you talk about India, it reminds me that you have an advantage if you put in new infrastructure.
Speaker: You obviously can go for the best infrastructure.
Speaker: And we see that across Asia, for example, when we built new subway lines immediately.
Speaker: Airports.
Speaker: Airports.
Speaker: You always put in the best.
Speaker: High school trains in China.
Speaker: Exactly, yeah.
Speaker: But I was struck.
Speaker: I was in the UK.
Speaker: And there's a fabulous new subway line, the Elizabeth Line, which connects Heathrow Airport all the way to the east side of London.
Speaker: Yeah.
Speaker: Fantastic, really well built and fast trains, great connectivity.
Speaker: But something that if you live in Asia, you find almost unbelievable and that is that on the train itself, you don't have 4G, let alone 5G connectivity.
Speaker: I thought you were going to say air conditioning, but okay.
Speaker: No, the air conditioning, I think, is there.
Speaker: Yeah, but you spend up to an hour on the train and of course, if you're in Hong Kong, you commute, you of course expect immediate connectivity and so forth.
Speaker: It's not on the line.
Speaker: It's not on the line.
Speaker: So I would put that under the list of in progress as well.
Speaker: Are they building on that?
Speaker: Are they working on that, improving that?
Speaker: So apparently there are plans to roll it out.
Speaker: It's available on the platforms now, but not on the train itself.
Speaker: And that's where you see passengers every time when the car runs.
Speaker: rolled into a station, frantically trying to update their emails.
Speaker: And then so we'll go back into the tunnel.
Speaker: Don't load it all, and then you can actually digest and read it, maybe.
Speaker: You're actually hoping for the train to stop a little bit longer at each station so you get that connectivity.
Speaker: But certainly that's in progress.
Speaker: But nevertheless, it's a wonderful, wonderful subway line in addition to the London Transport Network.
Speaker: It certainly makes life easier.
Speaker: And it shows again that maybe both in Europe and in Asia there's plenty of growth for the next decades to come as these things are being built out and people are going to benefit from it.
Speaker: And that about wraps up things for this edition for Under the Benya Tree.
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