2023-10-16 10:22:13 ET
Summary
- China's Golden Week produced some surprisingly positive data points.
- But the structural property overhang hasn't been cleared.
- Chinese ETFs like GXC screen cheaply but are probably more 'value trap' than 'value'.
The case for China entering a 'balance sheet recession' (a la Japan) is stronger than ever, following a slew of poor economic data in recent months and a faltering property market. Perhaps the best rebuttal against a prolonged downturn is China's money supply growth, which continues to run in the double digits (+10.3% YoY M2 growth in September), primarily on the back of credit expansion from government bonds. From here, though, Chinese growth will have to be sustained with far less state lending support, given the smaller remaining issuance quota. Monetary easing and incremental fiscal measures could pick up some slack, but it seems likely, in my view, that overall credit growth will begin decelerating in the coming months.
To be fair, some of the pessimism has been priced in, and that might appeal to bargain hunters. But without fundamental improvement, I would keep a close eye on the 'E' in P/E, as earnings could still be revised meaningfully lower from here. While I still like the consumer/tech parts of the SPDR S&P China ETF ( GXC ) as a beacon of resilience amidst the Chinese storm (see prior coverage here ), the rest of the GXC portfolio is probably more 'value trap' than 'value' at this juncture. Net, I am turning neutral ahead of the National People's Congress meeting later this month.
Fund Overview - A Broader Portfolio of Chinese H-Shares
The State Street ( STT ) managed SPDR S&P China ETF tracks the market cap-weighted S&P China BMI Index, a basket of listed Chinese stocks available to foreign investors. GXC differentiates itself by primarily investing in Hong Kong-listed shares, which negates many of the risks associated with the variable interest entity ownership structures adopted by Chinese depositary receipts listed in the US and globally.
In line with the increasingly pessimistic view on China, GXC has seen another quarterly decline in its net asset base to $845m (down from $1.1bn previously). The fee structure hasn't changed, though, and the 0.6% expense ratio remains in line with comparable China large-cap ETFs like the iShares MSCI China ETF ( MCHI ) but below the industry-leading 0.2% expense ratio offered by the Franklin FTSE China ETF ( FLCH ) (see coverage here ).
State Street
The GXC portfolio's sector breakdown remains focused on the Consumer Discretionary (26.1%) and Communication Services (16.6%) sectors. The relatively resilient Financial sector also remains a staple holding at 15.2%, while Industrial has been the biggest gainer over the last quarter at 8.0%, replacing Information Technology (7.7%) and Health Care (7.2%).
State Street
The fund's single-stock positioning is concentrated around China's largest consumer/tech names like Tencent Holdings ( OTCPK:TCEHY ), Alibaba Group ( BABA ), PDD Holdings ( PDD ), and Meituan ( OTCPK:MPNGF ). Outside of consumer/tech, the relative resilience of major bank holdings like China Construction Bank ( OTCPK:CICHY ) and Industrial and Commercial Bank of China ( OTCPK:IDCBY ) has also kept them in the top ten list. Outside of Tencent and Alibaba (combined ~17% exposure), the GXC portfolio is well spread across an expanded 1.2k stock portfolio (mainly H-shares), keeping the fund fairly well-diversified.
State Street
Fund Performance – Quarterly Decline Slows, Distribution Up
Q3 saw a relatively slower decline quarter-on-quarter, driving GXC's total NAV return to -7.4% for the year (-7.5% YTD in marker price terms). In tandem, the fund's long-term annualized return profile has also decayed by 20bps, now standing at +3.8% per annum since its inception in 2007. However, the (semi-annual) distribution yield has increased, reaching 2.9% on a trailing twelve-month basis – well ahead of comparable US-listed China funds. Having outpaced last year's run rate in H1, the ETF should exceed last year's $2.10/share distribution, a positive recovery following a series of challenging COVID-impacted years.
State Street
Golden Week Ushers in Some Encouraging Data Points
Chinese data has finally taken a turn for the better, as holiday spending picked up during last week's National 'Golden Week' holiday. Inflation (core CPI up 0.8% YoY; services up 1.3% YoY) and trade (narrowing decline in exports) were also positive, offering hope, particularly on the consumption side, for a better-than-expected growth outcome this year.
In my view, the most encouraging data point was stronger-than-expected credit data, helped by higher government bond issuances, along with improving household and corporate loan growth. In combination, this meant total social financing growth (a proxy for Chinese credit and liquidity) accelerated from last month - a positive surprise given the declining property sales backdrop.
TradingEconomics
Going forward, China is by no means out of the woods. The structural domestic property price weakness (including price caps ) persists despite the incremental fiscal and monetary easing measures in recent months. Given that ~70% of Chinese household wealth is tied to property, the primary concern is the potential knock-on effects on aggregate demand and a potential 'balance sheet recession' scenario.
Reuters
External headwinds aren't helping either, as the one-two punch of 'higher for longer' rates globally and oil price spikes weigh on the demand outlook. With limited headroom on local government balance sheets, this leaves the onus firmly on the central government's willingness to expand its fiscal deficit to support the economy. The upcoming policy meeting later this month will be key in this regard, though the offsetting risk of exacerbating structural imbalances means a large-scale stimulus catalyst for Chinese equities is unlikely to materialize anytime soon.
A Chinese Balance Sheet Recession Looms Large
It's been a surprisingly good Golden Week holiday for the Chinese consumer, but I wouldn't write off structural Japan-style economic concerns just yet. Credit growth (currently at a double-digit YoY pace) could face some headwinds through year-end as the government's bond issuance runway narrows. With limited offset from the monetary side, where incremental fiscal/monetary stimulus will likely be insufficient to offset a major property reset, achieving the +5% growth target will be challenging.
To an extent, Chinese equities are already priced for a bleak outcome, having reversed most of the post-COVID gains. Yet, downward earnings revisions are gathering pace, particularly on the ex-tech/consumer side, and the latest de-rate could prove to be a 'value trap' ahead of a further rebase in earnings expectations. Given the balance sheet constraints at the local government level, the upcoming NPC standing committee meeting probably won't offer anything game-changing but will be worth watching out for anyway.
For further details see:
GXC: A Chinese Balance Sheet Recession Looms Large