2021 had been an eventful year for China and the rest of the world. The year started off well across most major stock exchanges, with growth stocks rising in February 2021, coupled with a hopeful outlook as various pharmaceuticals announced their successful COVID-19 vaccine trials. Despite this, the year is expected to end very differently. Growth stocks have come down significantly while value stocks have outperformed in its place.
A brief summary of China Stocks’ turbulence in 2021
Uncertainty was the theme of the second half of 2021, with China accelerating regulatory actions on the internet sector and then on education and casino sectors. This led to a severe decline in the Chinese stock market. To add fuel to fire, the Chinese real estate sector began souring with major property developers missing debt repayments, which caused fear of defaults. This means that 2021 was a very volatile time with the peak to trough range of at least 20% of many major indices and a peak to trough range of more than 90% for companies that have been the worst impacted.
To mitigate the economic slowdown, the Chinese government provided support to traditional industries that were in line with the theme of its 14th five year plan. Consequently, the companies in these industries outperformed in 2021. Towards the end of 2021, as it became clear that the economy was slowing down due to the reasons mentioned previously, the Chinese government also reduced the reserve requirement ratio and enacted other policy easing measures to support the economy.
Looking at the one year performance of various indices listed below, it’s clear that China and Hong Kong have both significantly underperformed than most of its Western peers. The Chinese indices were able to hold up, supported by companies with favourable policy tailwinds that are aligned with its 14th five year plan. On the other hand, the Hong Kong indices probably produced one of its worst years as many of the Chinese companies listed on the HK exchange were industries that were most severely affected, such as the internet and property sectors.
Source: Bloomberg
Macroeconomic and interest rate outlook for 2022
The current economic expectation for 2022 is lukewarm with varied economic recovery across the world. As seen in Chart 2 above, the consensus is for the global 2022 economic growth to slow down as compared to 2021. This is due to monetary tightening by countries and economic blocs such as USA, UK and EU and also risks such as Covid lockdowns, inflation, supply chain disruption and tightened labour market conditions.
China’s economy is in a different economic phase as it is slated to continue carrying out monetary and fiscal easing. Moreover, China is likely to set a floor target for economic growth of 5.0% next year as it tries to balance a desire to rein in the real estate sector, with the need for stability and economic growth in a year of crucial political change.
To achieve an economic growth of at least 5.0%, the Chinese government needs to implement looser fiscal and monetary policies to help growth accelerate from its current level. The latest data has indicated that the economy continued to weaken in November, fuelling calls for more stimulus.
It’s important to note that the China’s ruling Communist Party will announce a once-in-a-decade leadership transition in the third quarter of 2022, with current President Xi Jinping widely expected to continue as party chief.
Based on past trends, during a year of political reshuffle the Chinese government would strive to carry out the transition from a position of strength. Some possible ways include beating the growth target and demonstrating China’s political clout and position in the world stage.
The Chinese government has previously relied on stimulating property construction to revive growth, an option that they may not be able to do in 2022. Hence, the central government has already instructed local governments to front-load infrastructure investment early in 2022. But to sustain spending in the longer term, the Chinese central bank will need to loosen monetary policy to help local governments increase borrowing.
Corporate investment could be another growth driver next year, with analysts expecting a broad measure of manufacturing investment to grow by 8% in 2022. This will require a faster pace of growth in bank credit to support these investments.
The Chinese labour market is currently facing a supply constraint as job cuts have been seen in sectors hit by tighter regulations such as the internet, education and casino sectors, while the woes of the property development sector has a significant domino effect on a broad range of industries reliant on this sector. Consumer spending could accelerate to provide upside to the economy if employment stabilises and officials are able to keep the Coronavirus outbreaks under control.
Some downside risks include a deeper-than-expected slowdown in the property market or a sustained hit to consumption from Covid-19 surges. If these risks materialise, the Chinese government’s commitment to avoid using the property market for stimulus will be severely tested.
China stocks’ outlook for 2022
The 2022 outlook is expected to be robust, with state owned companies underpinning growth. Industries with ESG themes such as people’s well-being, urbanisation and rural revitalisation, carbon neutrality, recycling and clean energy have performed well in 2021 and are expected to continue their performance in 2022. Other industries to keep an eye out for will be the technology sector, with key focus on subsegments such as 5G and hardware. You can read our complete guide to investing in China here.
Hong Kong stocks’ outlook for 2022
The key sectors to keep an eye on are the internet, property development, electric vehicle and clean energy sectors. Currently, the 2022 outlook for the internet and property development sectors is mixed and uncertain due to the regulatory actions and debt strain, respectively. But the electric vehicle and clean energy sectors could be a source of strength, with potential upside from favourable technological advancement and policy tailwinds.
Valuation of major indices (as of 21 December 2021)
| Index | Price to book (P/B) ratio | Price to sales (P/S) ratio |
| Hang Seng Index | 0.95 | 1.26 |
| Shenzhen Stock Index | 3.07 | 2.16 |
| Shanghai Stock Index | 1.65 | 1.20 |
| S&P 500 | 4.68 | 3.04 |
| Nasdaq 100 | 8.85 | 5.44 |
| ChiNext Index | 8.4 | 7.2 |
| Straits Times Index | 1.06 | 2.25 |
Looking at the table above, we can see that the Hang Seng Index (HSI) is by far the index with the lowest valuation from a P/B ratio perspective at 0.95x and a close second from a P/S ratio perspective at 1.26x. It is lower than most indices listed and could be a candidate for mean reversion based on the outlook mentioned above.
The Shenzhen stock index, which has many local Chinese companies and state-owned enterprises in industries with strong tailwinds, has held up well. However, the Shanghai Stock Index with industries such as property developers, airlines and financials has faced a similar fate to the HSI.
Conclusion
The performance of the Chinese and Hong Kong stock indices have diverged significantly in 2021 due to the differentiated components that make up each indices. The divergence may continue in 2022 as stocks in industries crucial to China’s 14th five year plan and aligned to ESG themes may continue to outperform. Meanwhile, stocks in industries such as internet, property development and casino may continue to lacklustre.
The macroeconomic outlook for 2022 is also less favourable than 2021, but with the Chinese government poised to carry out fiscal and monetary easing, we could see continued strength in the Chinese economy. As 2022 will be a year of leadership transition for the Chinese government, it will also be crucial to look out for further political developments and its impact on stocks.
After a volatile year, 2022 is likely to be as eventful with economic and political developments on the horizon. The differing valuations could continue to widen should the regulatory actions and adverse debt situation persist. On the other hand, we could see the HSI and Shanghai Stock Index catch up to valuation held by other indices should the situation stabilise.
If you’re interested in investing in China stocks and want to take advantage of the current lows, join Alvin at his next live webinar to learn how he finds Growth Dragons Stocks in China markets today.