Chinese equities could be 2025’s dark horse, but here’s what needs to happen

• While the September stimulus sparked a stock market rally, two-thirds of the gains were erased by the end of November, reflecting China's ongoing economic challenges and long-term structural issues.

• Although we removed China from our core allocation in June 2024, we believe there are reasons to consider it as a tactical allocation today. With the right combination of economic stimulus and long-term reforms, Chinese equities have the potential to emerge as a dark horse in the year ahead.

• In the near term, additional policies are needed to stabilise the property market, while stronger fiscal stimulus should be introduced to boost consumption. These measures would enhance consumer and investor sentiment, generating positive momentum in the stock market.

• We also believe structural reforms are essential to address China's confidence issues. Deregulation in capital markets and increased support for the private sector are key. If implemented, these changes could pave the way for a re-rating of Chinese equities.

• We project the MSCI China Index to rise 14% by FY2026. We maintain a 2.5 neutral star rating for China. Investors with a higher risk appetite may consider adding China as a tactical position to their portfolio.

In 2024, Chinese equities failed to stage a real rebound. While the stimulus announced in September triggered a rally in Chinese equities, two-thirds of the gains were wiped out by the end of November (Figure 1). Stock market aside, China continues to face significant economic challenges. Annual inflation stayed near zero, with November’s figure standing at just 0.2%. Consumer demand, as measured by retail sales, showed some improvement, rising 4.8% year-on-year in October, but it remains sluggish compared to historical growth rates. The issues of high local government debt and the property crisis are still far from being resolved.

Figure 1: Two-thirds of MSCI China’s stimulus-driven gains were erased by the end of November

In addition to these economic challenges, long-term structural concerns continue to raise alarms. Over the past two years, China has increasingly moved toward a more top-down, state-controlled economic model. Policy crackdowns on the internet, education, and video gaming industries, along with investigations into entrepreneurs, have suppressed corporate valuations and undermined investor confidence. This was clearly reflected in the 0.3% year-on-year decline in private fixed asset investment by the end of October 2024. Given these persistent structural challenges, we have removed China from our core investment portfolios in June 2024.

Chinese equities can be 2025’s dark horse if…

Although we have removed China from our core portfolio, its position as the world’s second-largest economy still presents compelling reasons to consider it for a tactical allocation. We believe China could emerge as a dark horse market in 2025, but two key conditions must be met for this to happen: economic measures and long-term policy reforms.

Condition 1: More stimulus to stabilise the economy

Since 24 September 2024, we have observed unprecedented policy coordination across various government agencies, all focused on tackling the country’s economic challenges. This concerted effort highlights the Chinese government’s stronger commitment to revitalising the economy (Table 1).

Table 1: Summary of policies to address China’s economic challenges

Problems	Policies announced
Property downturn	Supply-side: Expanded the coverage of the whitelist projects and increased the credit size from the current 2.2 trillion yuan to 4 trillion yuan by the end of 2024 Demand-side: Lowered the existing mortgage rate by 50 bps Lowered the downpayment ratio for first and second homes to 15% Lowered both 1Y and 5Y LPR by 25bps to 3.1% and 3.6% respectively Increased funding portion in affordable housing relending facilities from 60% to 100% Renovation of 1 million urban village units
Local government debt	A debt restructuring plan: A one-off resolution of 6 trillion yuan A total of 4 trillion yuan through special bond issuance (CNY 0.8 trillion annually across 5 years) The government will repay 2 trillion yuan in hidden debt related to urban renewal projects, which is set to mature in 2029 and beyond
Stock market	Encouraged listed companies to buy back shares A swap program worth 50 billion yuan to exchange risker assets with brokerages, fund companies, and insurers.
Financial system	Cut 7-day reverse repo from 1.7% to 1.5% Cut RRR by 0.5% to 9.5% for large banks Allocated 300 billion yuan in low-interest loans from the PBOC to commercial banks to support share purchases and buybacks of listed companies

We believe that the continuous stabilisation of the property market is crucial for China to turn around its economy. The comprehensive policy package aimed at helping developers complete projects, reduce housing inventory, and boost households’ purchasing power by lowering borrowing costs has successfully attracted some buyers back to the market. In October, new home sales by China’s top 100 developers rose by 7.1% year-on-year, marking the first increase since May 2023 (Figure 2).

We maintain the view that the property market may have bottomed out, but also recognise that resolving such a crisis will take a long time. October's positive sales growth benefitted from a low base, and the growth rate was modest compared to the scale of the previous declines. We believe it is too early to declare victory, and additional stimulus measures will be needed to sustain this positive momentum.

Figure 2: China’s new home sales posted positive growth for the first time in October over the past year

In 2025, further monetary easing will be crucial to stabilising the property market. Despite a 25 basis point cut in the benchmark loan prime rates on 20 October 2024, real borrowing costs in China remained high at 2.9% by the end of November, primarily due to persistently low inflation (Figure 3). These high costs, combined with weak household confidence, have led to sluggish demand for credit and properties over the past two years.

Moving forward, we believe China has both the willingness and capacity to loosen its monetary policy. On 9 December, China's top leaders signalled a shift from a "prudent" to a "moderately loose" stance to support economic stabilisation. With the US Federal Reserve expected to further cut rates, China could stimulate its economy without triggering significant capital flight or currency volatility.

Figure 3: China's real borrowing costs remained elevated throughout 2023 and 2024

Besides rate cuts, additional support is needed to reduce China’s high housing inventory and rebalance supply and demand in the property market. In addition to encouraging home purchases, China plans to renovate one million urban village units across 35 major cities, with efforts recently expanded to nearly 300 cities. However, the focus should be shifted to increasing the number of renovation units. As of the end of October 2024, we estimate approximately 3.1 trillion square meters of new home inventory, or 25.8 million units - far exceeding the one million unit renovation target. The relatively small scale of the renovation initiative means the pace of destocking, and thus the stabilisation of the property market will be slow.

The property market crisis has brought the issue of high local government debt to the forefront. Elevated debt repayments have also drained local government budgets, limiting their fiscal support over the past two years. During the NPC Standing Committee meeting in November 2024, China made addressing this a priority, unveiling a comprehensive debt restructuring plan to reduce hidden debt from 14.3 to 2.3 trillion yuan by 2028. If successfully implemented, the plan would ease the burden of high-interest payments on local governments and free up resources to support domestic consumption.

In 2025, fiscal stimulus will need to do the heavy lifting to boost consumption, especially with potential trade losses from increased US tariffs under Trump Administration 2.0 and rising trade tensions with Europe over electric vehicles. While the home appliance trade-in program has stimulated automobile spending, its limited scope has not reversed the broader trend of weak demand. Following the conclusion of the Central Economic Work Conference on 12 December 2024, top officials committed to shifting the policy focus toward boosting consumption in 2025. While they acknowledged the possibility of increasing the fiscal deficit and enhancing pension support, no specific measures to directly stimulate consumption were outlined.

We believe additional policies are necessary to both enhance the capacity and encourage the willingness of households to spend. These could include expanding the trade-in program, increasing subsidies or consumption vouchers for low-income families, and more importantly, improving job security. Supporting youth employment will be vital to boosting confidence and addressing the spending gap. Combined with property market stabilisation, these policies could improve consumer and investor sentiment, generating positive momentum in the stock market.

Condition 2: Structural reforms to sustain long-term growth

While the policies mentioned above may help lift sentiment, they alone will not be sufficient to sustain a market rally. China is facing a confidence crisis - one that cannot be resolved simply through stimulus or a temporary surge in consumption. The unsustainability of the stimulus-driven rally became evident in October, as major shareholders reduced their holdings to lock in profits from higher prices, leading to a sharp decline in the stock market.

Our calculations show that over 200 companies announced reductions in holdings following the stimulus in October and November, while fewer companies increased their holdings (Figure 4). This signals low confidence among major shareholders in their companies' earnings prospects and share price growth. Such weak investor confidence could undermine the People's Bank of China’s efforts to boost the stock market, including its loan program to support share repurchases.

Figure 4: More companies issued share reduction notices following the market rally

Long-term structural reforms are crucial to restoring confidence, with deregulation in the capital markets being a key factor. While aggressive bans on short-selling and quantitative trading may prevent short-term sell-offs, they fail to address the underlying causes of market decline. Similarly, while the national team can temporarily support the market through ETF purchases, any rally will be short-lived, as the stock market ultimately depends on the economic outlook and corporate earnings. Relaxing many current regulations would create a more open and transparent market driven by fundamentals, enabling companies to capture real productivity growth and boosting investor confidence in their investments.

Additionally, the private sector needs restructuring, with increased support for fundraising, better access to capital, and enhanced opportunities for companies to scale globally. China’s shift from entrepreneur-led firms to state-controlled companies, which started with Beijing's crackdown on sectors dominated by private businesses, has taken a toll on the stock market. According to the Peterson Institute for International Economics, private companies represented just 33.1% of total market capitalisation as of June 2024, down from a peak of 55.4% in June 2021 (Figure 5). By the end of June this year, seven of the top ten companies by market capitalisation were state-owned, with private companies represented only by Tencent, PDD, and Alibaba.

Figure 5: The market capitalisation of the private sector has shrunk significantly since June 2021

We believe the private sector can - and will - play a crucial role in helping China’s stock market rebound. For this to happen, China must restore competitive neutrality, ensuring that private and state-owned enterprises operate on equal footing. Private companies, especially in the internet sector - such as Tencent, Meituan, and JD.com - are demonstrating a notable earnings recovery in 2024 (Figure 6). In 2025, we anticipate that more companies within the consumer discretionary, information technology, and communication services sectors will see continued earnings growth. Amid the global electronics upcycle and the transition to green energy, numerous private companies are experiencing rapid growth in sectors such as solar panels (e.g., Longi) and electric vehicles (e.g., BYD).

Figure 6: Internet companies demonstrated a recovery in earnings in 2024

The success of the private sector will have far-reaching positive implications. Strengthened earnings and growth prospects in the private sector will naturally create better employment opportunities for younger generations. We believe that these structural changes—including the deregulation of the capital market and increased protection for private sector businesses—will pave the way for a re-rating of Chinese equities.

China can be considered for tactical allocation in 2025

In 2025, China can continue to be considered for tactical allocation. Since September 2024, China has taken proactive steps to address its economic challenges, and we expect further supportive measures in 2025. Investor sentiment is likely to improve if additional monetary and fiscal stimulus is introduced to stabilise the property market and support domestic consumption. However, any boost in sentiment will only lead to a sustainable market rally if long-term structural reforms are implemented. If these reforms take place, we believe China could emerge as a dark horse market in 2025.

Based on our fair P/E ratio of 10X, we project a target price of approximately HKD 72.0 for the MSCI China Index by FY2026 (Table 2), suggesting an upside potential of around 14.0% from the closing price on 29 November 2024. We maintain a neutral 2.5-star rating for China, considering both the potential for a stock market rally driven by stimulus in 2025 and the challenges associated with structural reforms.

Investors with a higher risk appetite may consider increasing their allocations to Chinese equities. For active investments, we recommend Fidelity China Focus A-ACC USD, and for passive investment options, we recommend the iShares Core MSCI China ETF (HKEX: 2801) or the iShares MSCI China ETF (NASDAQ: MCHI).

Table 2: China’s earnings projections till FY2026

MSCI China Index	2023	2024E	2025E	2026E
PE Ratio	13.05	10.81	9.45	8.77
Earnings Growth	5.22%	20.7%	14.3%	7.8%
EPS	4.84	5.84	6.68	7.20
Projected Fair Price (Based on fair PE ratio of 10X)				72.0
Upside				14.0%
Source: Bloomberg Finance L.P., iFAST Compilations Data as of 30 November 2024

Figure 7: MSCI China Index vs. EPS

Declaration:

For specific disclosure, at the time of publication of this report, the analyst who produced this report holds positions in iShares Core MSCI China ETF (HKEX: 2801).