2024 is the year of the dragon in the Chinese zodiac – a magnificent and mystical creature symbolising supernatural power, strength, and prosperity. As the most auspicious of all zodiac signs in Chinese culture, could the year of the dragon bring a change of fortune for China?
In short, 2024 is likely to remain an uphill battle for the Chinese economy and its markets. But before we look at why, it’s important to reflect on the context that brought us to where we are today.
Year of the flop
2023 may have been the year of the rabbit, but for investors in China, there was nothing cute and fluffy about it. Instead of roaring back after the end of its strict zero-Covid-19 strategy, China was plagued by the unfolding of a property crisis that saw two of its top property developers, Evergrande and Country Garden, go bankrupt. And despite the “around 5%” GDP growth target being met after significant government stimulus, it’s important to remember that 2022 provided a low comparison base.
The pessimism around China is reflected in the performance of its stock markets. The Hang Seng China Enterprise Index slumped 14.0% compared to a gain of 21.8% in the MSCI World Index. Putting how grim Chinese stocks are in perspective, at the end of January 2024 the Hang Seng Index to S&P 500 ratio had slumped to its lowest level since 1975.
Firing up the dragon
To avoid being overwhelmingly pessimistic on China, let’s take a step back and think about the potential positive developments in 2024.
The authorities have stepped up stimulus measures and they are increasingly pre-emptive and targeted in nature. At some point, they may well develop a “whatever it takes” attitude.
For example, in January in an unprecedented move, China’s central bank announced an impending cut in the reserve requirement ratio ahead of its official meeting date. There is also a clear signal of further monetary and fiscal easing measures to come in 2024. Consideration of a stock market stabilisation fund worth around two trillion yuan ($278 billion) shows the authorities will not turn a blind eye to the haemorrhage in Chinese stocks.
China has also backtracked on measures aimed to deter online gaming companies (after the evaporation of billions of market capitalisation for the affected businesses) which shows increased consideration for how regulatory changes can impact market sentiment. Of course, the risks of a broader regulatory crackdown (the main driver of the stock market downturn in 2021) remain, but the worst is probably behind us.
The external demand picture for China may look brighter too, with interest rates likely to be cut and an increased probability of a soft-landing in major economies in 2024.
Low Chinese asset valuations as a result of the depressed sentiment around China could also pique investors’ interest – could one of Warren Buffet’s many investment maxims, “be greedy only when others are fearful,” apply to how investors view China in 2024?
A market like no other
The problem with investment philosophy widely celebrated in the West is that it’s not always applicable to investing in China. The reason why? China is still a centrally directed economy and the state has tightened its grip on private companies in recent years.
For example, being a shareholder may not equate to participation in the future success of a company. Instead, shareholder capital may be used to serve the policy goals of the Chinese government and underwrite the risk in the process. In practice, Chinese authorities may order banks to increase lending to qualified real estate developers without collateral – is that in the best interest of the shareholders of the bank?
True, there are some sectoral bright spots in China in relation to industrial upgrade, artificial intelligence (AI) and de-carbonisation. Electric vehicle (EV) and solar panel production are booming, and China will be a key player in the world’s transition to renewable energy. Progress has been swift, perhaps best seen in BYD (Build Your Dreams) overtaking Tesla as the world’s biggest EV producer in 2023.
However, investors exposed to a broad equity index in China may find it difficult to benefit from these themes. The top ten constituents of the CSI 300 Index are dominated by state-owned banks and insurance companies, whereas the Hang Seng China Enterprise Index has a heavy weighting to Chinese technology giants, which remain under scrutiny in the name of national security.
Even if you target the companies that may benefit from secular tailwinds, many Chinese companies producing and supplying the world’s renewable energy infrastructure are heavily state-subsidised and are not necessarily profitable. These industries may also be challenged by the increasingly protectionist stance of the West, which may become a focal issue for the China hawks in the upcoming US election. During the US-China trade war under Donald Trump’s presidency, 2017-21, Chinese equities significantly underperformed those in the US.
The stakes are high in the beleaguered property sector
Simply put, economic confidence in China will be steered by the property sector in 2024.
The crisis is still unfolding. There is no sign of a turnaround in home sales, which means reduced cash generation and heightened stress in meeting debt obligations. This creates a downward spiral for the economy; lower property investments could lead to lower economic growth which could lead to lower home sales.
The liquidation order of Evergrande, a once leading Chinese developer, will be complicated and investors will have to wait years to retrieve assets. Crucial to sentiment recovering will be whether unfinished residential units are completed and delivered to homebuyers who have already paid. Chinese authorities and Evergrande have made this a priority but it’s worth watching how this one unfolds.
From the government’s perspective, rather than rescuing individual companies, it is trying to make aggregate financial conditions easier for both developers and homebuyers. While there are macro goals to channel more funding to the property sector, it is hard to anticipate a major recovery in 2024 as banks have remained cautious and selective in their lending. Not helping matters is the expectation that refinancing pressures will remain high for property developers in 2024 and 2025, according to Moody’s.
While stimuli such as lower mortgage rates, reduced downpayment ratios, and relaxed home purchase restrictions are helpful, the boost in actual home sales following the introduction of these measures was short-lived. Lower-tier cities which represent the bulk of national home sales, may not react much given weak macro conditions, confidence, and demographics.
So, what’s the verdict? Well, unless there is a revival in the property market, consumers’ appetite to spend may be limited, especially given around 70% of Chinese household wealth is tied to property. The property crisis also highlights the wider difficulty in rebalancing China’s economy from one driven by fixed investments such as infrastructure, construction, and manufacturing, to an economy deriving growth from services and consumption.
Will the dragon take to the skies in 2024?
The transition to the year of the dragon is exciting, and for those who are superstitious, it may bring about new energy and fortune.
However, practically speaking, the profound issues in the property sector will take years to resolve. Neither is the relationship between the state and private companies likely to change anytime soon, whichever zodiac year we are in. The domestic policy environment remains unpredictable and the upcoming US election may bring about more protectionist threats against China’s technology and industrial sectors.
On the positive side, the authorities are likely to manage and contain the financial risks in the economy. There may be more forceful easing rolled out, foreign reserves are ample to counter any shocks, technology progress continues, and external demand could recover in 2024 if developed economies achieve a soft-landing scenario.
With this turbulent backdrop, it’s unsurprising that Chinese equities have become very cheap. After falling in seven of the past 10 years, it’s unlikely to see further big drawdowns in 2024. That being said, for markets, it’s going to take a lot more than the prospect of easing and better economic data to turn their entrenched negativity around. China could really do with the year of the dragon living up to its name.
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