Riding the Chinese dragon in 2024? It’s no easy feat!

• Chinese stocks find themselves among the worst performers on the global stage. The index failed to rebound in 2023.

• The property market faces ongoing challenges, and is anticipated to decline further due to sluggish purchasing demand dragged by a shrinking population and waning consumer confidence.

• Both consumers and businesses remain cautious in their spending and investments. Confidence levels have yet to bottom, indicating the need for more supportive measures.

• Geopolitical tensions continue to pose a significant concern, despite recent diplomatic softening.

• Our expectations for 2024 include a moderately expansionary fiscal policy and a further loosening of the monetary policy regime. Attracting foreign capital will become a top priority for China in 2024.

Chinese stocks find themselves among the worst performers on the global stage in 2023. The economic landscape in China for the 4Q23 remained sluggish, with the official manufacturing and non-manufacturing PMIs contracting month over month. Investor confidence remains at a nadir, as reflected by the 11.0% year-to-date decline in the MSCI China Index. This underperformance starkly contrasts with the rallied indices of other key markets (Figure 1).

Figure 1: MSCI China Index Was One of the Worst Performers in 2023

Looking ahead to 2024, we anticipate that China's path to recovery will be fraught with challenges. Headwinds such as a weak demand for the housing market, coupled with low consumer and business confidence, are expected to persist. Despite witnessing a heightened level of focus on housing and economic policies, we remain cautious about the prospect of a market turnaround within the next year.

The Property Market Will Continue to Sink

The overall confidence in China's real estate market continues to hover at a notably low level, as evidenced by the Real Estate Climate Index registering at 93.42 in November. With an index of 100 points deemed as the ideal benchmark for housing market prosperity, the recorded 93.42 underscores a prevailing pessimism towards the real estate market.

On the supply side, as of November 2023, property investments have experienced a year-over-year decrease of 9.4%, with the decline widening month over month (Figure 2). However, noteworthy progress has been observed in house deliveries. The implementation of the central bank's CNY 350 billion special funds and a CNY 200 billion loan support program have contributed to an approximately 20% year-over-year improvement in delivery rates since April 2023, reflecting the Chinese government's commitment to ensuring the completion of existing projects.

Figure 2: China Property Investment Growth Rate YoY 

On the demand side, despite government efforts such as reducing loan prime rates, relaxing home-buying requirements, including a lower down payment ratio, and extending loan maturity tenure, these housing policies failed to make a significant impact. According to Beijing Zhong Zhi Hong Yuan Data Information Technology, the value of new home sales among the 100 largest real estate companies still experienced a year-over-year decline of 14.7% as of November 2023. The persistent downturn in new home sales underscores the challenges in stimulating demand, even with the multifaceted approach taken by the government to enhance affordability and encourage home purchases.

As more projects reached completion in 2023 amid a slowdown in demand, a substantial oversupply has emerged. November 2023 data from the National Bureau of Statistics reveals a surge in unsold housing floor space to 318.13 million square meters, marking a 20.4% year-over-year increase. However, this official metric only accounts for completed unsold properties, neglecting the fact that approximately 80% of property sales occur through pre-sale channels. When considering pre-sale properties, the estimated total unsold space could reach around 3.29 billion square meters (Figure 3).

Figure 3: Property Inventory Reached 3.29 Billion Square Meters

On the other hand, second-hand properties now constitute a significant portion of total market sales. According to 58 Anjuke Research Institute, at the end of November, 5.46 million properties were posted online for sale through the secondary market in the top 100 developed cities. Assuming an average household occupancy space of 111 square meters, this equates to 606.55 million square meters. Combining the inventory of properties in both primary and secondary channels, destocking the current inventory would take approximately 4.54 years, given no new property construction.

Yet, China's aging and diminishing population appears unable to uphold such excessive supply. In 2022, China witnessed its first population decline, with a decrease of 0.85 million, attributed to more families postponing childbirth and reducing the number of children. Moreover, China's home ownership rate reached 96% in 2019, indicating saturation in the market demand for houses. The predominant demand now stems from the "sell old and buy new" dynamic, which is highly responsive to property prices and market sentiment.

To consume excessive properties, China has initiated urban village renovation projects, aiming to transform underdeveloped districts that were previously engulfed by expanding cities. The appeal of lower rents and living standards in these urban villages has attracted a significant influx of workers from rural areas. As of October 2023, there are 162 planned projects set to unfold in 8 megacities and 23 large cities. However, these endeavours are not without challenges. State-owned property developers highlighted the stringent renovation standards imposed by authorities, proving difficult to meet. Moreover, these developers already grapple with a list of longstanding stalled redevelopment projects.

Financial constraints pose another hurdle, with local governments wrestling with debt associated with local government financing vehicles (LGFVs). Renovation costs have to initially be shouldered by private capital, with government funding coming later from its coffers and through debt issuance. Given the current economic climate, private enterprises are less inclined to invest. Beyond the challenges posed by construction, households with lower incomes in these areas may face difficulty affording new houses.

Not Yet An End To The Confidence Crisis

Chinese consumers’ confidence failed to improve, evident in this year’s 11.11 sales.  Major e-commerce giants, Taobao/Tianmao and JD, chose not to disclose their gross merchandise value (GMV). According to data from the third-party infotech platform Syntun, the aggregate sales numbers increased by a mere 2.2% year over year, marking the lowest increment since Taobao launched the event in 2009. The sales trend also indicates that consumers are adopting a more prudent approach to their purchases, actively seeking value-oriented goods. As such, there has been a shift towards more affordable domestic brands.

Decreased household spending can be attributed to the challenging labour market and persistently declining salaries. Average salaries in 2023 saw a decline of 0.4% compared to 2022, with three quarters witnessing reductions (Figure 4) - an occurrence not observed since 2016.

Figure 4: China’s Average Salaries Fell For 3 Consecutive Quarters In 2023

China’s business confidence also remains at a depressed level. The official manufacturing PMI contracted to 49.0 in December 2023. Surveys revealed that over 60% of manufacturing companies reported insufficient market demand. Notably, fixed asset investments continue to be closely tied to property investments. Given China's investment focus on urban village renovation, the outlook for fixed asset investments in 2024 is expected to remain lackluster.

Market confidence has taken another blow due to the latest draft regulations in the video gaming industry. Proposed measures include prohibiting daily login rewards and potential spending limits on online gaming platforms. However, investors fear broader implications. This move contradicts President Xi's pro-investment signals, undermining efforts to rebuild investor confidence and impacting gaming companies like Tencent, NetEase, and Bilibili. The new regulations also weighed on other tech companies, with Alibaba, Meituan and Kuaishou falling on the news. Despite China adopting a softer tone and dismissing Feng Shixin, the head of the publishing unit at China’s Publicity Department a few days later, the market remained skeptical. The mixed signals released from Beijing have left investors in greater confusion and doubt.

The prevailing low confidence is evident in aggregate financing, a board measure of credit. Although the overall lending volume remained at a substantial 2.45 trillion in November 2023, a closer look at the composition reveals a distinct narrative. Government debt now outweighs RMB loans as the main source of credit demand. Historically, RMB loans comprised 50%-80% of aggregate financing, but in July and October 2023, they plummeted to 6.8% and 26.2%, respectively (Figure 5). This implies that the spending and investment demand from households and businesses is currently at historically low levels.

Figure 5: Majority of The Aggregate Financing Originated from Government Debt

Geopolitical Tensions Remained A Concern

China has recognised that prolonged geopolitical tensions not only impede its consumption and capital growth but also pose a serious threat to its innovation capabilities, particularly in the current economic climate marked by a property downturn. In response, China has opted for a more accommodating foreign policy to bolster trade performance and enhance business confidence.

During the recent APEC summit in San Francisco, China resumed the dialogues with the US and agreed to cooperate on trade controls on chemicals. President Xi also conveyed a clear message during a dinner with CEOs from major U.S. technology companies, expressing a welcoming stance toward investments in China. This aligns with Beijing's latest business regulations aimed at improving the operating environment for foreign companies. Looking ahead to the first quarter of 2024, China and the U.S. are set to hold a vice-ministerial-level dialogue, addressing crucial issues such as semiconductor export controls, sanctions on Chinese companies, restrictions on bilateral investments, and the U.S. Section 301 tariff measures on China.

Moreover, China is proactively repairing its relationships with other Asian markets, including Vietnam and Japan. We anticipate President Xi to increase diplomatic visits in 2024. Given the challenging scenario of sluggish domestic demand making it difficult to reverse the Chinese market's trajectory, attracting foreign capital appears to be the most viable strategy for market revitalisation in 2024.

Nevertheless, we acknowledge that despite indications of increased economic cooperation, political tensions are unlikely to diminish. It is anticipated that President Biden will maintain a stringent approach in restricting China's access to AI and semiconductors, particularly as he seeks re-election in 2024. The US and its alliance are expected to uphold a firm position on sensitive territorial matters, such as the disputed Taiwan and Diaoyu Islands. As such, despite a more softening tone leading up to presidential meetings, we maintain the view that geopolitical risks persist.

Looking forward to 2024

Fiscal policy for 2024 leans towards moderate expansion, with heightened leverage from the central government. Sustained support is imperative for key sectors like LGFVs and urban village renovation programs. The Chinese government is poised to increase stimulus efforts to bolster the recovery of the property market.

We also anticipate a further relaxation of the monetary policy regime. Given the persistent deflationary pressures in China, an exceptionally loose monetary policy is imperative to discourage savings. November's data shows a concerning inversion of -8.7% in M1-M2 (Fig 6), reflecting weak economic vitality. In November, M1 grew a mere 1.3% YoY while M2 maintained a generally high YoY increment of 10%. This suggests that households and businesses are favouring long-term deposits over liquid options like short-term deposits and cash.

Figure 6: Money Supply

With the money supply growth rate yet to reach its bottom, 2024 could see additional rate cuts and downward adjustments in the reserve requirement ratio (RRR). Furthermore, considering the Federal Reserve's indication of a potential 75 basis points cut in the Fed funds rate in 2024, the narrowed yield differentials provide added impetus for China to lower its loan prime rate. Cutting the 5-year loan prime rate will serve as the key to stimulating mortgage demand.

China has once again established a 5% economic growth target for 2024 during the Central Economic Work Conference. However, we hold the view that achieving this target will prove challenging. The growth observed in 2023 benefited from a favourable comparison base, given the constraints imposed by the coronavirus in 2022 and heightened consumer enthusiasm in the first half of 2023 after reopening.

Consequently, reaching the 5% target in 2024 hinges on the success of efforts to attract foreign capital and establish new trade agreements. However, after witnessing regulations cracking down on technology, then tuition, and now gaming industries, foreign investors are hesitant to re-enter the Chinese market. Regulations now stand as a significant deterrent to attracting foreign investors.

As of now, we maintain our view that China’s market continues to be shrouded in uncertainties. We advocate exercising caution when investing in the region. We will only wait and see the effectiveness of the pro-foreign investment policies and their ability to reshape the market in 2024. Given our fair PE ratio of 10.0X, we find the Chinese market unattractive for investment at this time, with an upside potential of only -3.8% by 2025 (Figure 7).

Figure 7: MSCI China Index Share Price and EPS Performance

Table 1: EPS and Upside Projection Of The MSCI China Index

However, for those still interested in investing in China, options like the E-Fund CSI 300 ETF (SSE:510310) or the Allianz China A Shares Fund can still be considered. A-shares listed companies typically demonstrate greater liquidity and higher valuations compared to those listed in Hong Kong.

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.