The The The

The wonderland of equities

Equities 8 minutes to read
PG
Peter Garnry

Head of Equity Strategy

Summary:  Chinese equities bounced back massively with Hang Seng up 9% today as the Vice Premier Liu He said in a speech that the Chinese government intends to support stocks including Chinese ADRs and the economy which is under pressure from higher commodity prices and lockdowns due Covid-19 outbreaks. We go through our views on Chinese equities and whether the recent declines are a buying opportunity. We also go through the different factors that are causing headwinds for global equities despite the recent positive comeback for equities which include rising input costs from commodities and tighter financial conditions.


Liu He speech sparks massive rebound in Chinese equities

Chinese equities have been in a free fall since the recent high on 10 February down 27% as of yesterday’s close as the war in Ukraine has amplified headwinds for the Chinese economy and sentiment on Chinese equities. Institutional investors have recalibrated their exposure to emerging markets due to the war in Ukraine and China’s stance towards Russia during the war has been negative for sentiment among foreign investors. Commodity market volatility and prices have accelerated due to sanctions on Russia which have added more pressure on the Chinese economy which is a heavy commodity importer. Finally, China is battling new covid outbreaks in Hong Kong and on the mainland forcing several regions including Shenzhen into lockdown aggravating headwinds for the economy.

But today the Vice Premier Liu He delivered a speech in which he vowed support for Chinese equities including overseas ADRs listed in the US on top of promises of more support for the economy. Hang Seng gained 9% today closing above yesterday’s close. Talk about supporting equities in many ways are cheap talk and the negotiations with the US over the upcoming auditing requirements for Chinese companies listed in the US could still fail. However, the indicated measures to support the Chinese economy is what really matters for the equity market.

We have many clients that are asking about our view on Chinese equities and specifically Chinese technology stocks. In fact the KraneShares CSI China Internet ETF has been one of the most traded instruments recently suggesting massive attention on Chinese equities among investors. Our stance on Chinese technology stocks has been the same for over a year when the new policies common prosperity started to have an impact regulation and sentiment. We are cautious on Chinese technology stocks as long as they are valued at a discount to US technology companies as a premium in technology is a strong signal on growth outlook and technology. But what about the general Chinese equity market?

Normally, we would use some measure of valuation to operating income such as EV/EBITDA for a comparison on valuation, but for emerging markets it is often better use the dividend yield because this measures real cash outflows from companies diminishing any potential issues around accounting profits. As the chart below shows, Chinese equities are not outright cheap compared to global equities.

Source: Saxo Group

Have equities lost their connection to reality?

You always have to be careful when you go against the market consensus because markets are pretty efficient after all. But equities do seem out of touch with reality with European equities down only 2.3% from the close before Russia’s invasion of Ukraine and Brent crude has given up most of its gains since the war started. The only rational explanation for this pricing is that the market is increasingly betting on Russia’s stalling military campaign will lead to a quick peace. That logic has been vindicated today with an official announcement from Kremlin that a neutral Ukraine with their own army is a possible compromise. While this is a positive step things could still change and one would also think that part of any deal is Russia seeking Europe to roll back sanction under some reasonable timespan.

But even if we get peace in Ukraine the sanctions on Russia will maintain for some time and the ripple effects in commodity markets will continue to endure. In addition, the constraints on the supply side of our economy will continue to haunt companies through inflation. Investors need to remind themselves of what the fundamental drivers of equity valuation are:

  1. Revenue growth
  2. EBITA margin
  3. Incremental investments
  4. Discount rate

Of these four factors only revenue growth is trending positive for equity valuations as the massive fiscal stimulus is creating both inflation and higher nominal growth. However, inflationary pressures, disruptions in the global supply chain, wage pressure, and high commodity volatility are creating headwinds for operating margins which have declined in the previous quarter and no week goes by without more and more companies lowering their outlook for margins; today both BMW and Fevertree were out with a lower operating margin outlook. As the global economy is constrained on the supply side due to a decade of underinvestment and companies are shoring back production in from Asia in a response to the fallout from the pandemic, the incremental investment need will go massively over the coming decade. Yesterday, Intel announced the first plans for its €80bn investment plan over the next 10 years in Europe covering R&D facilities, manufacturing and foundry services. Finally, the discount rate is moving higher with the US 10-year yield hitting almost 2.2% and central banks in an inflation fighting mode suggesting that financial conditions will tighten.

Overall, the vector is negative for equity valuations which still remain at the 87% percentile measured over the period 1995-2022 (see chart). In our view equities will go to its average historical valuation reflecting inflation and the disruption in commodity markets.

Source: Bloomberg
Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-hk/legal/disclaimer/saxo-disclaimer)

Saxo Capital Markets HK Limited
19th Floor
Shanghai Commercial Bank Tower
12 Queen’s Road Central
Hong Kong

Contact Saxo

Select region

Hong Kong S.A.R
Hong Kong S.A.R

Saxo Capital Markets HK is a company authorised and regulated by the Securities and Futures Commission of Hong Kong. Saxo Capital Markets HK Limited holds a Type 1 Regulated Activity (Dealing in securities); Type 2 Regulated Activity (Dealing in Futures Contract) and Type 3 Regulated Activity (Leveraged foreign exchange trading) licenses (CE No. AVD061). Registered address: 19th Floor, Shanghai Commercial Bank Tower, 12 Queen’s Road Central, Hong Kong

By clicking on certain links on this site, you are aware and agree to leave the website of Saxo Capital Markets, proceed on to the linked site managed by Saxo Group and where you will be subject to the terms of that linked site.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

Please note that the information on this site and any product and services we offer are not targeted at investors residing in the United States and Japan, and are not intended for distribution to, or use by any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation. Please click here to view our full disclaimer.