China will overcome Covid-19.  But will its markets recover?

China will overcome Covid-19. But will its markets recover?

For Chinese equity investors, when and if Beijing will finally ease its strict Covid-19 and real estate control measures are basically the only questions on their minds lately. There are signs that real change may finally be on the horizon.

But the more structural conundrum remains: how profitable will investing in the Chinese market be over the next decade, even assuming the best of real estate and Covid-19?

Chinese stocks rebounded this month after two horrific years. The MSCI China jumped 21% in November as Beijing refined its tough pandemic measures and stepped up support for the struggling real estate sector. Even after the rally, the index has still lost more than half of its value since the start of 2021, virtually erasing all of the gains of the past decade.

A quick turnaround in China’s Covid-19 policy or the real estate market is unlikely. The recent surge in Covid-19 cases and the resulting lockdowns across the country are a solid reality check for the giddy optimism that was evident in some press and brokerage reports earlier this month. But the feeling that the worst is over is likely to continue to drive the market in the months to come, especially given the real situation for Chinese equities. The Hang Seng China Enterprises Index is trading at nine times forward earnings according to FactSet, sitting just above its lowest levels in decades.

Trading multiples for Chinese stocks have fallen, but that doesn’t answer the question of how much investors should pay. According to Citi, earnings per share for stocks in the MSCI China index fell 31% from their peak last October, with real estate, technology and consumer stocks leading the decline. An eventual reopening of the economy will help boost earnings, but it will likely take months yet.

More importantly, long-term earnings growth in China has long lagged other countries, and there are now new reasons to expect this trend to continue. MSCI China’s earnings per share have remained stable since 2010 despite strong economic growth, notes Citi. During the same period, the earnings per share of the MSCI USA index increased by 9% per annum.

Part of the reason is that while earnings growth of old-school Chinese market favorites such as state-owned energy and telecom companies has slowed, they still make up a large chunk of the index. Chinese scholarship. But the engine of earnings growth that was meant to replace those stable stocks — China’s once buoyant internet sector — is now facing structural headwinds following the concerted onslaught of regulators over the past two years.

Plus, it’s unclear what might rise to take their place. China faces an uphill battle in the very capital-intensive chip sector. And while it has serious competitors in electric vehicles and batteries, those industries are still in their infancy and could face further technological disruption from abroad.

In other words, even if China’s economy rebounds significantly as Covid-19 and property sector controls ease, it’s far from clear that this will translate into robust earnings growth for investors. medium term. A China focused on massive – and perhaps wasteful – capital expenditure to seek self-sufficiency in key industries might not be a China that offers outsized rewards to public equity investors.

Write to Jacky Wong at jacky.wong@wsj.com

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