The Dragon Bouncing Back
Swift dismantling of zero-Covid policy in China has triggered a surge in demand resulting in robust economic recovery. Is this a flash in the pan or a structural shift?
Bouncing off from 2022 bottom in early November, Chinese equities (represented by FTSE China 50 Index, "China50 Index") rallied 64% on COVID easing. The rally has stalled based on specific sector weaknesses causing a 12% correction in February.
This paper argues that record revenues (over CNY holidays in January), anticipated pro-growth Government stimulus, record-levels of consumer savings, and loose monetary policy will collectively drive Chinese equities higher.
A long position in CME’s E-Mini FTSE China 50 Index futures will deliver a reward-to-risk ratio of 2.35x while riding this economic shift.
SECOND LEG OF RE-OPENING TO LEAD TO RECOVERY
Five reasons support our bullish stance on Chinese equities:
First, favourable technical signals. Stalled rally plus weak sentiments have caused the markets to retrace 12%, leaving it right below a key Fibonacci retracement level. This suggests that the FTSE China 50 Index could continue its upward trajectory in 2023 as reopening turns into recovery.
Second, pro-growth fiscal policies. Investors hold high anticipation of upcoming National People's Congress (NPC) scheduled for early March. During the “Two Sessions,” the government is expected to make pro-growth policy announcements to boost the economy.
Historical analysis shows that the Two Sessions (NPC plus top political advisory body meeting) tend to provide solid tail winds to the stock market. Shares have previously rallied ahead of the meetings and afterwards as investors digest the news. Over the last decade, real estate & healthcare shares delivered the largest excess returns following these meetings.
Third, accommodative monetary policies. Meanwhile, PBOC added liquidity into the financial system to meet a rapid rebound in loan demand. PBOC kept short-term & long-term Loan Prime Rate (LPR) unchanged for the sixth straight month. Short-term LPR was at 3.65%. Long-term LPR (used to calculate mortgage rates) was at 4.3%. Both are at their lowest level in 20 years as China tries to balance economic growth and currency stability.
Fourth, revenge spending. Forced to stay home due to Covid restrictions & unable to spend, Chinese consumers saved one-third of their income last year, depositing RMB 17.8 trillion (USD 2.6 trillion) into banks. Even for a thrifty nation like China, that's massive. With restrictions gone, will Chinese consumers revenge to spend their excess savings?
Finally, valuations of Chinese shares are seemingly still in bulls’ favour despite the reopening rally. The MSCI China Index is trading at 10.9x forward P/E, below the 10-year average of 11.2x.
In tandem with equity market price retracement, China centric commodities such as Iron Ore and Copper have also stalled. But are looking to rise again.
ECONOMIC DATA PAINTS A HOPEFUL FUTURE AHEAD
Economic data from China show positive signs of economic recovery in 2023. Purchasing Manager Index (PMI), an important leading indicator of business activity, rebounded sharply in January.
GOVERNMENT PRIORITIZING ECONOMIC GROWTH
The Chinese government has announced stimulus packages to support its struggling Real Estate and Tech Sectors. For instance, Guangzhou recently committed $29 billion to local tech funds to inject capital into high-tech sectors.
The government also announced a 21-point plan in January to boost property developer’s balance sheets with $67 billion in aid.
Moving in tandem with pro-growth Government accommodative fiscal policy, the PBOC continues its commitment to accommodative monetary policy by keeping key short- and long-term Loan Prime Rate (LPR) at their lowest level in almost two decades to boost growth.
However, this monetary stimulus comes at the cost of rising inflation in the country.
PROFESSIONAL INVESTORS ARE BULLISH CHINA AGAIN
In a note recently published by Goldman Sachs, the bank expects Chinese stocks to surge as much as 24% by the end of this year as the economy shifts from reopening to recovery.
The bank highlighted that "professional speculators" on their prime brokerage platform are showing a greater appetite for Chinese stocks.
Goldman highlighted that hedge funds had substantially re-risked their exposure in offshore Chinese equities with net Chinese exposure to total equity exposure reverting to all-time highs.
FOREIGN INVESTORS ARE BULLISH CHINA TOO
HKEX's Stock Connect program’s north bound flows shows that foreign investors heavily bought into Chinese equities in January and continue to so do in February despite retracement.
The Shanghai Northbound Stock Connect, which allows HK investors to access Chinese equities listed on Shanghai Stock Exchange (SSE) saw net buying of RMB 83.4B so far in 2023.
The Shenzhen Northbound Stock Connect shows net purchases of RMB 74.1B this year. In comparison, these investors bought RMB 9.6B of Shanghai & RMB 25.4B Shenzhen shares in December.
Besides the connect program, foreign investment into China scaled up in January to the highest level since June 2022. Foreign investors bought RMB 128 billion ($18.7 billion) according to China’s Ministry of Commerce. That was 14.5% higher YoY and a 75% jump in investment into high-tech manufacturing. This spike reversed two months of double-digit drops in late 2022.
DEMYSTIFYING THE CHINA 50 INDEX
The FTSE China 50 Index comprises of the 50 largest and most liquid Chinese stocks that are listed and traded in Hong Kong. The index is specifically designed for international investors to get exposure to Chinese equities.
The China 50 index is dominated by large tech stocks representing 23.4% of the index. Bank stocks have a 18% weightage with retailer shares weighing in at 15%.
The overall index provides a balanced with a mildly skewed tech exposure to Chinese equities.
TRADE SET UP
With a raft of Government and PBOC policies supporting Chinese economic recovery amplified by optimistic investor sentiments, this paper proposes a long position in CME’s E-Mini FTSE China 50 Index futures expiring in June 2023 to harvest a 2.35x reward to risk ratio.
Each futures contract offers exposure to $2 x China 50 Index.
Entry: 12,990
Target: 15,800
Stop: 11,800
Profit at Target: $5,620
Loss at Stop: $2,380
Reward-to-Risk Ratio: 2.35x
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/gopro/
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Bouncing off from 2022 bottom in early November, Chinese equities (represented by FTSE China 50 Index, "China50 Index") rallied 64% on COVID easing. The rally has stalled based on specific sector weaknesses causing a 12% correction in February.
This paper argues that record revenues (over CNY holidays in January), anticipated pro-growth Government stimulus, record-levels of consumer savings, and loose monetary policy will collectively drive Chinese equities higher.
A long position in CME’s E-Mini FTSE China 50 Index futures will deliver a reward-to-risk ratio of 2.35x while riding this economic shift.
SECOND LEG OF RE-OPENING TO LEAD TO RECOVERY
Five reasons support our bullish stance on Chinese equities:
First, favourable technical signals. Stalled rally plus weak sentiments have caused the markets to retrace 12%, leaving it right below a key Fibonacci retracement level. This suggests that the FTSE China 50 Index could continue its upward trajectory in 2023 as reopening turns into recovery.
Second, pro-growth fiscal policies. Investors hold high anticipation of upcoming National People's Congress (NPC) scheduled for early March. During the “Two Sessions,” the government is expected to make pro-growth policy announcements to boost the economy.
Historical analysis shows that the Two Sessions (NPC plus top political advisory body meeting) tend to provide solid tail winds to the stock market. Shares have previously rallied ahead of the meetings and afterwards as investors digest the news. Over the last decade, real estate & healthcare shares delivered the largest excess returns following these meetings.
Third, accommodative monetary policies. Meanwhile, PBOC added liquidity into the financial system to meet a rapid rebound in loan demand. PBOC kept short-term & long-term Loan Prime Rate (LPR) unchanged for the sixth straight month. Short-term LPR was at 3.65%. Long-term LPR (used to calculate mortgage rates) was at 4.3%. Both are at their lowest level in 20 years as China tries to balance economic growth and currency stability.
Fourth, revenge spending. Forced to stay home due to Covid restrictions & unable to spend, Chinese consumers saved one-third of their income last year, depositing RMB 17.8 trillion (USD 2.6 trillion) into banks. Even for a thrifty nation like China, that's massive. With restrictions gone, will Chinese consumers revenge to spend their excess savings?
Finally, valuations of Chinese shares are seemingly still in bulls’ favour despite the reopening rally. The MSCI China Index is trading at 10.9x forward P/E, below the 10-year average of 11.2x.
In tandem with equity market price retracement, China centric commodities such as Iron Ore and Copper have also stalled. But are looking to rise again.
ECONOMIC DATA PAINTS A HOPEFUL FUTURE AHEAD
Economic data from China show positive signs of economic recovery in 2023. Purchasing Manager Index (PMI), an important leading indicator of business activity, rebounded sharply in January.
GOVERNMENT PRIORITIZING ECONOMIC GROWTH
The Chinese government has announced stimulus packages to support its struggling Real Estate and Tech Sectors. For instance, Guangzhou recently committed $29 billion to local tech funds to inject capital into high-tech sectors.
The government also announced a 21-point plan in January to boost property developer’s balance sheets with $67 billion in aid.
Moving in tandem with pro-growth Government accommodative fiscal policy, the PBOC continues its commitment to accommodative monetary policy by keeping key short- and long-term Loan Prime Rate (LPR) at their lowest level in almost two decades to boost growth.
However, this monetary stimulus comes at the cost of rising inflation in the country.
PROFESSIONAL INVESTORS ARE BULLISH CHINA AGAIN
In a note recently published by Goldman Sachs, the bank expects Chinese stocks to surge as much as 24% by the end of this year as the economy shifts from reopening to recovery.
The bank highlighted that "professional speculators" on their prime brokerage platform are showing a greater appetite for Chinese stocks.
Goldman highlighted that hedge funds had substantially re-risked their exposure in offshore Chinese equities with net Chinese exposure to total equity exposure reverting to all-time highs.
FOREIGN INVESTORS ARE BULLISH CHINA TOO
HKEX's Stock Connect program’s north bound flows shows that foreign investors heavily bought into Chinese equities in January and continue to so do in February despite retracement.
The Shanghai Northbound Stock Connect, which allows HK investors to access Chinese equities listed on Shanghai Stock Exchange (SSE) saw net buying of RMB 83.4B so far in 2023.
The Shenzhen Northbound Stock Connect shows net purchases of RMB 74.1B this year. In comparison, these investors bought RMB 9.6B of Shanghai & RMB 25.4B Shenzhen shares in December.
Besides the connect program, foreign investment into China scaled up in January to the highest level since June 2022. Foreign investors bought RMB 128 billion ($18.7 billion) according to China’s Ministry of Commerce. That was 14.5% higher YoY and a 75% jump in investment into high-tech manufacturing. This spike reversed two months of double-digit drops in late 2022.
DEMYSTIFYING THE CHINA 50 INDEX
The FTSE China 50 Index comprises of the 50 largest and most liquid Chinese stocks that are listed and traded in Hong Kong. The index is specifically designed for international investors to get exposure to Chinese equities.
The China 50 index is dominated by large tech stocks representing 23.4% of the index. Bank stocks have a 18% weightage with retailer shares weighing in at 15%.
The overall index provides a balanced with a mildly skewed tech exposure to Chinese equities.
TRADE SET UP
With a raft of Government and PBOC policies supporting Chinese economic recovery amplified by optimistic investor sentiments, this paper proposes a long position in CME’s E-Mini FTSE China 50 Index futures expiring in June 2023 to harvest a 2.35x reward to risk ratio.
Each futures contract offers exposure to $2 x China 50 Index.
Entry: 12,990
Target: 15,800
Stop: 11,800
Profit at Target: $5,620
Loss at Stop: $2,380
Reward-to-Risk Ratio: 2.35x
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/gopro/
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Full Disclaimer - linktr.ee/mintfinance
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