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The recent sell-off in the China equity market has left global investors questioning the underlying causes and future implications. This downturn stemmed from a combination of domestic macroeconomic issues, potential decoupling concerns, and global macroeconomic and geopolitical risks. Despite the fundamentals of China’s market and international investment flows not materially deteriorating in the near term, uncertainties persist.
What Happened in the China Equity Market?
The sell-off in the China equity market followed a period of negative performance that began in early 2021, intensifying in March 2022. Various factors, both domestic and global, contributed to this downturn. The global equity market, as measured by the MSCI ACWI Index, returned 19% in 2021, but the China equity market, represented by the MSCI China Index, declined by 21.6%. This decline continued into the first quarter of 2022, with the MSCI China Index falling an additional 14%, culminating in a 54% drop from its peak on February 17, 2021, to its trough on March 15, 2022.
Long-Term Performance of the China Equity Market
The MSCI China Index’s consensus long-term forward earnings per share (EPS) growth rate, which was higher than that of the rest of the world for much of the last decade, saw a significant drop since mid-2021. This decline reflected global investors’ growing concerns about the long-term growth prospects of China’s listed companies.
Main Performance Drivers of the China Equity Market
Several factors have driven the performance of the China equity market:
Global Geopolitical Tensions
The Russia-Ukraine war significantly impacted global markets, including the China equity market. Rising inflation and monetary tightening by central banks worldwide further exacerbated these concerns.
Domestic Macroeconomic Headwinds
China has been dealing with its own economic challenges since 2021. The U.S. Holding Foreign Companies Accountable Act (HFCAA) requires companies listed on U.S. stock exchanges to declare they are not owned or controlled by a government, creating delisting risks for many Chinese companies. Additionally, Executive Order 13959, which bans transactions by U.S. persons in publicly traded securities of companies identified as “Chinese military companies,” has also contributed to market volatility.
Regulatory Changes and Delisting Risks
China’s domestic regulatory changes and the risks associated with the HFCAA have had a direct impact on U.S.-listed Chinese companies and P chips. This has been reflected in the performance disparity across different share classes within the China equity market. For instance, while China A shares returned 3.4% in 2021, U.S.-listed Chinese companies and Hong Kong-listed P chips dropped by 38% and 27%, respectively.
Evaluating Recent Developments in the China Equity Market
Despite the challenges, some recent developments indicate efforts to stabilize the China equity market. The Chinese government has targeted issues such as the real estate debt crisis, regulatory changes, and HFCAA concerns in recent Financial Stability and Development Committee meetings and the National People’s Congress.
Impact of the Russia-Ukraine War
The ongoing Russia-Ukraine war continues to be a significant concern, impacting global economic stability and investor sentiment. This geopolitical tension has added another layer of complexity to the China equity market.
COVID-19 and Macroeconomic Effects
The latest COVID-19 outbreak in China and its potential macroeconomic effects remain critical concerns for investors. The government’s response to these challenges will be pivotal in shaping the future trajectory of the China equity market.
Sentiment vs. Fundamentals in the China Equity Market
While the market sentiment has been largely negative, it’s important to assess whether this has translated into fundamental changes. Compared to global markets, the return on equity (ROE) of the MSCI China Index has not materially deteriorated, either in absolute terms or relative to the market’s valuation level. However, overseas-listed Chinese companies, which are highly exposed to both domestic regulatory changes and the HFCAA, have been notable outliers in terms of return on equity and price-to-book value.
Fund Flows and Investor Behavior
March 2022 saw an outflow of USD 9 billion from the China equity market, ending 17 consecutive months of positive net inflows. While significant, this outflow was not extreme when compared to similar events during the early COVID-19 outbreaks in March 2020 (USD 11 billion) and the U.S.-China trade conflict in May 2019 (USD 8.5 billion).
Uncertainty in the China Equity Market
The China equity market has been significantly impacted by both internal and external headwinds. Despite positive commitments from Chinese authorities, uncertainty remains high. Investors need to monitor developments closely, especially regarding regulatory changes, geopolitical tensions, and macroeconomic indicators. Understanding these dynamics is crucial for navigating the volatile landscape of the China equity market.
By keeping a close eye on these factors, investors can better assess their China exposure and make informed decisions in an uncertain market environment.
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