- The CSI 300 Index fell 5.5% over the past week and Hong Kong’s Hang Seng was down 5% over the same period as investors became increasingly worried over tighter regulation of domestic companies, especially in the education space.
- Goldman is remaining overweight on Chinese stocks, partially because they see them getting a boost from potential fiscal-policy easing.
- Some sectors are particuarly “growthy” to Goldman’s analysts: software, semiconductors, (green) energy/utilities, and autos.
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Chinese stocks absorbed one of their worst routs in years this past week as regulators stepped up their efforts to rein in the activities of everything from technology companies to education firms, spooking investors and wiping billions of value off the stock market.
Goldman Sachs this week slashed its forecast for Chinese stocks in light of the crackdown which it called “unprecedented in terms of its duration, intensity, scope, and the velocity of new policy announcements.”
A more uncertain regulatory environment has sent volatility skyrocketing and made certain parts of one of the world’s most valuable equity markets “uninvestable,” in their words. But Goldman’s Asia equity analysts say there are still plenty of good reasons for global investors to have top-notch Chinese stocks as part of their portfolios.
After the initial shock of Chinese regulators taking aim at private-tutoring companies and other education-related firms — along with technology companies — the government moved swiftly to stem the tide of foreign capital outflows in the wake of the market turbulence.
The government met regulators and top global investment bank representatives to convey three main messages: any policy changes would be isolated to the education sector; they would be gradually introduced to avoid sharp volatility in the markets; and the moves were not aimed at decoupling Chinese-US financial markets.
But China’s CSI 300 index still logged a 5.5% decline on the week, while Hong Kong’s Hang Seng was down 5% over the same period — the biggest weekly drops since February for both indices.
Some market fears have receded, but the investing terrain will remain rocky until a “new normal” is achieved, Goldman said. The bank’s analysts recently ran a few different regulatory risk scenarios against Chinese stocks, dividing them into private- (POE) and state-owned enterprises (SOE).
Following its analysis, the bank said it had neutralized its views on the MSCI China index, where POEs account for around 80% of the index’s total value, but remained overweight on China A shares — those of mainland China-based companies that trade on the Shanghai Stock Exchange and the Shenzhen Stock Exchange — “given its favorable sensitivity to potential (fiscal) policy easing, lower POE/Tech weightings, and robust Northbound flows potential.”
Goldman further contended that the “growthy” sectors it identified through its analysis were software, semiconductors, (green) energy/utilities, and autos as they were “less exposed to potential regulation shocks.”
Here are six key reasons why Goldman’s analysts remain optimistic, particularly about China A shares:
- The social sectors in the POE universe amount to 35% of total listed market cap, and those that are at (regulation) risk (i.e. seeing relatively high price inflation over the past 5 years) represent only 25% of the full-universe market cap.
- Given the Chinese government’s support for developing foundational technologies and nurturing innovation to support high-quality growth, Goldman’s analysts said they still are of the view that the authorities would be pragmatic when striking a balance between social/ideological goals and capital markets in non-social sensitive industries over time.
- The underlying demand in the digital economy is unlikely to be structurally damaged by regulations if they are confined to select areas.
- In GS’ view, current investor sentiment is comparable to the 2015 market selloff where China A experienced a peak-to-trough drawdown of 43% and 31% of market cap was suspended trading at one point. However, when concerns dissipated and confidence gradually recovered, foreign portfolio inflows resumed and surpassed previous highs, roughly one year after the incident.
- From a long-term macro perspective, the new regulations could potentially lead to a more balanced economy, in terms of growth drivers and resource allocation, foster fairer competition, and lower systemic risk in the highly levered sectors, among other advantages.
- The overwhelming regulation concerns have overshadowed policy support in select areas that are aligned with national development objectives, notably green energy, electric vehicle, enterprise/B2B software, semiconductor, and “New Infrastructure”.