My Take on the Stock Market's March Madness

A year after the U.S. market cratered during the Covid-19 crash, the S&P 500 ended the month of March at a fresh record high. Overall, the U.S. benchmark index has gained almost 77% within the year since the March 2020 bottom.

Nevertheless, March wasn’t exactly a smooth ride. Concerns about the potential for higher inflation, rising bond yields, and the collapse of the investment fund Archegos Capital drove a good amount of volatility in stock prices. However, apart from these worries, the year already is off to a solid start: Both the DJIA and also the S&P 500 posted a fourth straight quarter of gains, with the 2 indexes rising 7.8% and 5.8% within the first quarter of 2020, respectively.

Returns for the MSCI China Index, however, has fallen over 30% since the mid of Feb.

Wthi the recent pullback, I wanted to give an update on China, whether it is still an attractive investment opportunity given that I have always been quite optimistic and favorable of this market.

Outsized Presence of Growth Stocks

One of the reasons for the recent drop-off is mainly the China tech companies like Alibaba and Tencent. These companies take up a huge percentage of the MSCI China Index.

As you can see from the breakdown of the MSCI China Index, you will see that there is a very large allocation to sectors such as Consumer Discretionary (Which includes Alibaba) as well as Communication Services (Which includes Tencent) These companies have relatively high valuations due to their run in 2020. Investors took some profits off the table and resulted in some sell-off in the market. There has been a general rotation not just in China but also globally from the growth sectors into some of your financial and value sectors. Together with worries over the rising interest rate environment, tech stocks tend to be your longer-duration assets. They are also more sensitive to interest rate changes and as a result of that on a whole all these tech-related stocks have actually sold off a lot more as compared to other sectors within the economy.

Emerging Risk Factors

Some other factors that have also resulted in a sharp correction in Chinese equities would be the possible tightening in terms of financial conditions within China as well as the increased regulatory scrutiny on the domestic and external side. I think that these 2 factors had resulted in an investor sentiment-driven sell-off.

Let's dive deeper into some of these risk factors:

1. The possible tightening of financial conditions

Guo Shuqing, Chairman of the China Banking and Insurance Regulatory Commission (CBIRC) and Party secretary of the central bank expressed concerns about the risks of bubbles emerging in global financial markets and the country’s property sector, at a briefing in Beijing.

China has expressed intentions to reduce leverage within the property sectors. They also want to improve the use of capital within its economy and reduce some of the risks they face within China that could actually result in a larger problem for the economy itself.

My Opinion:

The days of loose monetary policies are ending. However, I think that the risk of drastic money tightening in terms of monetary conditions is low and China is more likely to proceed with policy normalization via a gradual tapering instead of drastic tightening and moving ahead. China’s inflation also doesn't show signs of overheating as household consumption still remains sluggish. I am not expecting the Chinese government to actually cut or have a drastic policy stance, for both monetary and fiscal policies in China.

Even with the shift in financial conditions from a moderate to a more neutral stance, I don't think that this will slow China's growth.

2. China Internet Giants facing rising regulatory scrutiny

Domestically, we have also seen how Chinese policymakers have been tightening their antitrust stance. Cases like the Chinese Government slapping a $2.8B fine on Alibaba and recent investigation into companies like Tencent, Meituan on monopolistic practices, have also resulted in a sell-off of these Chinese Internet giants.

On the external front, we also see how the US has also been enforcing tighter regulations on Chinese companies, especially those that are listed on the US stock exchanges.

My Opinion:

The intentions may be to weed out some of the systemic risks rather than to constrain innovation within the Chinese companies. All these regulations safeguard consumers in the longer term and promote healthy competition and sustainable growth of the Chinese tech sector in the long run. If we take a look at the early days of these big tech companies, the government has also protected all these companies in the early days by providing an environment where all these companies could actually innovate and be protected from all the global monopolies (Google, Facebook, Amazon). We have also seen how the majority of all these Chinese tech companies growths is due to the network effect and superior product offerings rather than a significant anti-competitive behavior and these platforms continue to remain China’s focus to build up its domestic economy and also plays a very crucial role in China's ambitions to be globally competitive in the tech space. I believe China is unlikely to dampen the growth of all these companies but rather to build up an environment that builds up healthy competition and sustainable growth for these sectors moving ahead.

So what do I think of investing in China now?

I think there is still a bright outlook for China, if we look at the economic data that is coming out, it is still very optimistic.

Looking at the China Industry Chart, we can see that Industrial production rose 14.1% year-on-year in March (January–February: +35.1% yoy). I would still keep some level of skepticism as some of this growth is due to a low base effect from one year ago when they were in the lockdown phase.

If you take a look at the PMI data, they are all still in the expansionary territory, with some slight moderation recently. But overall I expect that the recovery within china still remains strong, With resilient export numbers.

In terms of the GDP numbers, analysts expect the GDP growth for the Chinese economy to come in around 8.5 percent this year. Export outlook for the first and 2nd half of the year continues to be very rosy, while demand for Chinese goods will also continue to benefit from a stronger global economy due to faster than expected reopening globally due to mass vaccination programs and also positivity from the fiscal stimulus from the US. I think the combination of factors will help to drive and boost the demand for Chinese goods moving ahead and this will help to support the Chinese economy this year.

In Summary

I am still very optimistic about Chinese equities, but I will continue to keep a lookout on some of the risk factors like the rising risk from the tightening of monetary and fiscal policy within china as well as the tech sector regulation. I still see that the economic data coming out from China to be promising and signify a strong v-shaped recovery.