How will China's risk assets perform next year? According to UBS, the internet sector will lead the way, and the market is expected to rebound by 15%.

Wallstreetcn
2023.11.27 08:44
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In 2023, influenced by complex geopolitical and macroeconomic factors, the MSCI China Index has fallen more than 6% year-to-date, the CSI 300 has dropped over 9%, and the Hang Seng Index has declined by more than 13%. However, looking ahead to 2024, UBS believes that recent macroeconomic indicators in China have shown some improvement, and the revenue and profitability of large listed companies have stabilized. Coupled with the expected interest rate cuts by the Federal Reserve, as well as the low valuations after the sharp decline, Chinese risk assets are expected to rebound by as much as 15% in 2024. The bank also stated that for 2024, the preferred industry sectors are internet, education, food and beverage, and sportswear, with the internet sector expected to take the lead.

In 2023, influenced by complex geopolitical and macroeconomic factors, the MSCI China Index has fallen more than 6% year-to-date, the CSI 300 has dropped more than 9%, and the Hang Seng Index has declined by over 13%.

However, looking ahead to 2024, UBS believes that recent macroeconomic indicators in China have shown some improvement. Large listed companies have stabilized their revenue and profitability, combined with the expected interest rate cuts by the Federal Reserve, and the low valuations after the sharp decline, Chinese risk assets are expected to rebound by as much as 15% in 2024.

The bank also stated that the preferred industry sectors for 2024 are the internet, education, food and beverage, and sportswear, with the internet sector expected to lead the way. UBS analysts also mentioned that from the perspective of industry composition and short selling levels, they prefer Hong Kong stocks and US ADRs.

Optimistic about the prospects of Chinese risk assets in 2024

Analysts believe that there are three major improvements in the market in 2024 compared to this year:

  • It is expected that the real interest rate of the US 10-year Treasury will decline, which may benefit emerging market stock markets including China;
  • Revenue and profitability are expected to improve, especially for large listed companies;
  • As some companies shift their focus from growth to shareholder returns through more reasonable investments, increased buybacks, and expenditures, the return on net assets is expected to further increase.

UBS pointed out that despite the poor performance in 2023, there are still six reasons to remain optimistic about Chinese risk assets in 2024:

  1. Improvement in macro data, especially holiday consumption trends, industrial activities, and credit support;

  2. After the July Politburo meeting, the Chinese government introduced a series of supportive policy measures, many of which were better than expected by investors, including relaxing housing policies, reducing personal income tax, and issuing 1 trillion yuan of special central government bonds;

  3. Multiple technical indicators show that the market may be approaching the bottom, including a large outflow of foreign capital, low market turnover, and rising short-term interest rates. In addition, the renminbi and government bond yields are at historically low levels;

  4. Valuations and downside room for positions are limited, as market valuations are close to a 5-year low, and foreign investors have very limited positions;

  5. With the improvement in corporate earnings, the profitability situation may rebound to some extent;

  6. UBS's commodity team predicts that major commodity prices in 2024, including thermal coal (-22%) and iron ore (-13%), will average a 10% decline, further easing cost pressures and benefiting downstream profit margins.

Positive macro outlook, with frequent positive news at home and abroad

In terms of macro data, UBS stated that China's macro data has bottomed out and continues to improve in recent weeks.

The industrial enterprise profit data released today shows that the profits of large-scale industrial enterprises in October increased by 2.7% year-on-year, achieving positive growth for three consecutive months, and the profitability of industrial enterprises continues to improve.

Other data includes:

  • The manufacturing PMI and industrial production have improved for three consecutive months;
  • Industrial enterprise profits have turned positive;
  • Holiday consumption and monthly retail data reflect further improvement in consumption trends; and
  • Credit support has rebounded from negative values.

At the same time, UBS also pointed out that since July, China's macro policy support has been increasing, mainly manifested in:

  • Implementation of large-scale urban village transformation;
  • Reduction of income tax for small and medium-sized enterprises and stamp duty for stock trading;
  • Relaxation of multiple housing policies, including lifting purchase restrictions in certain areas of first-tier cities, reducing mortgage rates and down payment ratios, etc.;
  • Central Huijin's purchase of state-owned banks and ETFs to boost market sentiment;
  • Issuance of 1 trillion yuan of special bonds by the central government to support infrastructure projects such as water conservancy and hydropower.

Based on the above considerations, UBS believes that by 2024, the following characteristics will be reflected in China's macro economy:

  • Consumption will still be a key driving factor for growth, and economists expect consumption to continue to recover, with excess savings being moderately released;
  • Although economic growth will slow down, exports should also improve slightly, mainly offset by the rise in the global technology cycle.
  • Due to the high base of infrastructure expenditure in 2023, and the continued downturn in real estate, the growth rate of infrastructure and manufacturing FAI will slow down to 5-6%.
  • Real estate is still a drag, but the impact is relatively small. It is expected that real estate sales and investment will decline by 5%, and new construction area will decline by 10%. Although the real estate market is still full of challenges, investors' expectations are relatively low;
  • The overall fiscal deficit is slightly higher, ranging from 3.5% to 3.8%, but it is still moderate;
  • Continue to implement loose monetary policy, but not adopt aggressive easing policies.

In addition, looking at the global economic forecast for next year, there are also many factors that are favorable for the Chinese economy.

UBS predicts that global GDP will record a growth of 2.6% in 2024, which is 0.5 percentage points slower than in 2023; the United States will enter a mild recession in the second or third quarter, and global interest rates will decline. Among them, the Federal Reserve is expected to cut interest rates by 275 basis points. Historically, lower interest rates in the United States can boost emerging markets including China. In addition, as a highly export-oriented economy, China will also benefit from the boost of the new wave of technology.

Investment Strategy: Internet sector expected to lead; automobile stocks least recommended

Regarding the allocation of risk assets, UBS pointed out that although growth stocks currently have relatively higher valuations compared to historical averages, it is expected that the performance of growth stocks next year will slightly outperform value stocks.

In addition, considering that large-cap stocks usually perform better in market recoveries and that the current trading prices of large-cap stocks are 1.5 standard deviations higher than small-cap stocks, it is recommended to allocate more to large-cap stocks. The bank believes that these 20 high-quality large-cap stocks have not only consistently outperformed global and domestic indices, but their valuations are currently at historical lows. The EPS of these 20 large-cap stocks is expected to grow by 18% in the next 2 years.

UBS stated:

We believe that these high-quality stocks, which are rated as "buy" regardless of whether the Chinese stock market recovers or not, have the potential to rise. We define market leaders as companies that have leading market shares in their respective industries and have good corporate governance.

In terms of sector allocation, the bank is most optimistic about the performance of the internet sector:

The internet sector is still our most favored sector because both in absolute terms and relative to its counterparts in the United States, the valuations of this sector appear to be low.

In the past 12 months, internet companies have prioritized shareholder returns by controlling costs and increasing share buybacks. It is widely expected that the profitability of this sector will continue to improve during the period from 2021 to 2023.

Furthermore, UBS also pointed out that the consumer sector, including food and beverage, beer, sportswear, and catering, which experienced a significant decline in 2023, is now not only undervalued but also has low investor expectations, thus it is expected to rebound next year:

The returns of the sub-markets in 2023 have shown significant deviations. For example, large consumer goods such as automobiles and home appliances have outperformed small consumer goods such as beer and sportswear. Although consumer recovery is lukewarm, non-essential consumer goods (including luxury goods) have performed better than major consumer goods. Since consumer spending is unlikely to improve significantly next year, we will focus on the lower-priced consumer groups.

The sectors that UBS is least optimistic about are the automobile, banking, and infrastructure-related industries:

1. The automobile sector is overvalued (compared to other sectors, it is one of the sectors with the highest prices), and the base effect next year will be higher;

  1. In the coming quarters, the banking industry will continue to face multiple pressures, including refinancing of existing mortgage loans, non-performing real estate loans, and refinancing of local government financing platforms. These measures to support macroeconomic recovery may lead to a contraction in net interest margins for banks, which is unfavorable for the sector's performance. Considering the decline in infrastructure spending and the slowdown in global economic growth, the growth of the construction and machinery industries will slow down.