Macro: Sandcastle economics
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Are Chinese stocks ready to outperform?
Peter Garnry
Chief Investment Strategist
Summary: Chinese equities were rallying 3.6% today on signals from the Chinese government to curb inflationary pressures from rising commodity markets reducing inflation expectations and boosting the earnings outlook. US equities are currently valued at a valuation premium to Chinese equities which suggest historically that Chinese equities could outperform over the next 26 weeks. The two country's technology sectors are equally valued on a 2-year forward basis on EV/EBITDA but with a valuation skew on Chinese technology mega caps making them more attractive on valuation. The long-term growth outlook is better for Chinese technology companies and thus we expect the market to begin leaning into Chinese technology stocks.
As we alluded to in today’s podcast, CSI 300 futures (tracking mainland China equities) broke out higher up 3.6% during the session. The Chinese government’s signaling that it would curb excesses in commodity prices pulled technology stocks globally higher as lower commodity inflation means less pressure on interest rates which in turn means less pressure discount rates on future cash flow. Lower input prices also lift future profit margins and earnings growth.
Chinese companies operate generally at lower profit margins and thus respond more to expectations about inflation and interest rates as the marginally change on profits are bigger for low margin businesses. China’s stimulus has also been limited this year as the country is enjoying the tailwind from stimulus in the US and Europe, but it is our expectation that as that growth momentum slows down the Chinese government will take over a launch more stimulus to keep the economy humming. This should underpin the earnings growth outlook for Chinese equities.
Last Friday, we wrote about how cheap mega cap Chinese technology stocks have become measured on FY22 free cash flow yield which is almost twice some of the largest US technology stocks. On a 2-year horizon Chinese technology stocks (Hang Seng TECH) are valued at the same equity valuation as US technology stocks (Nasdaq 100) which is cheap in a historical context because of the better growth outlook for Chinese technology companies. Broadening out the scope US equities are right valued at a 6% valuation premium to Chinese equities compared to a historical 5% discount for US equities.
Chinese equities were beginning to get back to their historical valuation premium over US equities in the beginning of the year, but the hedge fund Archegos’ collapse and the Chinese crackdown on the technology sector have for now negatively impacted investor sentiment. The current US equity valuation premium suggest that Chinese equities could outperform over the coming 26 weeks, but this prediction comes with a wide prediction interval and the key assumption of this trade is that Chinese equities will move back into premium. Helped by better growth outlook and a weaker USD we believe that is most likely the trajectory.
For inspiration on Chinese technology and consumer stocks looks at our China consumer and technology equity theme basket consisting of 40 stocks.
| Name | Industry | Market Cap (USD mn.) | Sales growth (%) | EPS growth (%) | Diff to PT (%) |
| Tencent Holdings Ltd | Gaming & social media | 754,001 | 27.4 | 24.1 | 26.0 |
| Alibaba Group Holding Ltd | E-commerce | 570,528 | 40.7 | 8.7 | 40.7 |
| Kweichow Moutai Co Ltd | Beverages | 430,228 | 9.9 | 10.3 | 8.4 |
| Meituan | E-commerce | 217,752 | 17.7 | NA | 42.8 |
| Pinduoduo Inc | E-commerce | 163,441 | 97.4 | 29.8 | 34.1 |
| Kuaishou Technology | Social media | 110,153 | 50.2 | NA | 59.8 |
| JD.com Inc | E-commerce | 111,717 | 33.3 | 112.9 | 45.2 |
| China Tourism Group Duty Free Corp Ltd | Duty free goods | 103,383 | 45.7 | 190.6 | 11.5 |
| Midea Group Co Ltd | Household appliances | 91,518 | 18.4 | 17.8 | 25.7 |
| Foshan Haitian Flavouring & Food Co Ltd | Food seasoning manufacturer | 91,219 | 19.2 | 23.1 | 0.1 |
| Xiaomi Corp | Smartphone manufacturer | 90,108 | 19.4 | -8.9 | 12.7 |
| Hangzhou Hikvision Digital Technology Co Ltd ** | Video surveillance | 95,234 | 19.1 | 12.3 | 5.1 |
| Baidu Inc | Online search & advertising | 66,817 | 6.5 | 30.9 | 62.5 |
| NetEase Inc | Gaming | 76,156 | 24.6 | -17.4 | 17.7 |
| BYD Co Ltd | Car manufacturer (EV & ICE) | 73,076 | 51.9 | 376.8 | 33.1 |
| KE Holdings Inc | Housing transaction platform | 61,939 | 86.9 | NA | 43.3 |
| NIO Inc | Car manufacturer (EV) | 58,806 | 202.3 | 37.9 | 64.9 |
| Gree Electric Appliances Inc of Zhuhai | Air conditioners | 52,472 | 1.5 | 7.0 | 36.9 |
| Nongfu Spring Co Ltd | Beverages | 63,747 | -4.8 | 7.5 | 3.9 |
| WuXi AppTec Co Ltd | Drug manufacturing technology | 64,345 | 37.7 | 59.0 | 17.1 |
| ANTA Sports Products Ltd | Sports apparel | 54,397 | 4.7 | -1.6 | -0.5 |
| JD Health International Inc | Online healthcare platform | 46,642 | 78.8 | NA | 32.2 |
| Haier Smart Home Co Ltd | Household appliances | 41,873 | 4.5 | 134.8 | 29.2 |
| Foxconn Industrial Internet Co Ltd | Networking equipment | 39,201 | 10.2 | 7.0 | 39.9 |
| Will Semiconductor Co Ltd Shanghai | Semiconductors & image sensory | 39,988 | 50.1 | 228.4 | 21.0 |
| Semiconductor Manufacturing International Corp ** | Semiconductor foundry | 34,779 | 19.3 | 147.9 | 11.7 |
| Luxshare Precision Industry Co Ltd | Connectivity manufacturer | 43,579 | 38.6 | 34.7 | 30.0 |
| SAIC Motor Corp Ltd | Car manufacturer (EV & ICE) | 36,887 | 10.2 | 42.2 | 18.0 |
| Haidilao International Holding Ltd | Restaurant chain | 31,270 | 7.8 | -91.4 | 35.8 |
| BOE Technology Group Co Ltd | Display panels manufacturer | 34,828 | 40.4 | 793.5 | NA |
| Tencent Music Entertainment Group | Music streaming | 25,812 | 17.9 | 31.8 | 54.2 |
| Shenzhou International Group Holdings Ltd | Textile manufacturing | 39,156 | 1.6 | 0.1 | -9.3 |
| XPeng Inc | Car manufacturer (EV) | 23,376 | 216.9 | NA | 65.4 |
| Sunny Optical Technology Group Co Ltd | Optical instruments | 26,578 | 0.4 | 19.4 | 22.7 |
| Yum China Holdings Inc | Restaurant chain | 27,398 | 10.2 | 20.5 | 9.5 |
| Trip.com Group Ltd | Online travel agency | 24,891 | -45.1 | NA | 17.2 |
| Focus Media Information Technology Co Ltd | Offline advertising solutions | 24,854 | 20.0 | 238.9 | 29.0 |
| ZTE Corp | 5G & telecommunication | 19,949 | 18.0 | 124.4 | 35.9 |
| Oppein Home Group Inc | Household furniture manufacturer | 14,979 | 30.2 | 43.9 | 12.4 |
| Topsports International Holdings Ltd | Sports retailer | 9,618 | 6.9 | 4.2 | 19.0 |
| Aggregate / median | 3,986,697 | 19.3 | 26.9 | 26.0 |
Source: Bloomberg and Saxo Group
* Sales and EPS growth is measured on 12-month trailing figures, Diff to PT is the difference between consensus price target and the current price in %
** These companies are under US sanctions
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