Goldman knows one thing for sure about Chinese equities in 2018 and that’s this:
But, one thing we could say confidently: our current 2018 views are unlikely to stay unchanged as we go through the year.
So you know, they might as well have just put a big “take this with a grain of salt” stamp at the top of their China outlook piece, but this being Goldman, there’s still a lot of utility in hearing them out.
As you’re probably aware, Chinese shares suffered a pretty dramatic selloff on Thursday thanks to two things:
- jitters about the bond market
- an ongoing rout in shares of liquor maker Kweichow Moutai, a heavy weight that had apparently run too far too fast in the eyes of Beijing
Kweichow Moutai has fallen 12% over the last six sessions:
The bond market jitters stem from investor concerns over Beijing’s ongoing efforts to deleverage the financial system, and the recent release of a proposed set of new rules for AMPs has only added to the concerns. All told, AMP AUM (which encompasses all of your favorite Chinese shadow vehicles including WMPs and trust deals) sits at roughly CNY100 trillion. If you account for the cross holdings, it’s probably something like 60% of that total.
Generally speaking, there’s no telling what’s going to happen when that gets squeezed and the new rules look like they’re set to turn the screws on superfluous SPV layers and try to remedy some of the rampant maturity mismatch thats part and parcel of some of these structures. That seems like it could spell trouble for the bond market and if there’s trouble there, it could spill over like it did on Thursday.
But who knows. As Goldman admits, Chinese equities are a moving target – figuratively and literally in this case. Speaking of targets, here are Goldman’s for Hong Kong and China:
And here’s some of the accompanying color, including the macro drivers and breakdown for the offshore forecast:
Profit growth, a key return propellant in 2017, should stay strong despite slower GDP growth, supported by a robust nominal economy (10.2%) and ‘New China‘ sectors–we forecast 18% EPS growth in 2018, modestly lower than the 20% run-rate in 9M17. Valuations are unlikely to re-rate 26% the way they have in 2017, constrained by above-mid-cycle PE (14.0x) and rising US rates, which could disproportionately hurt long-duration equities including Tech/BAT, most likely in 2H. Valuation pressures from higher yields should be mitigated by a unique and constructive liquidity story, anchored by structural Southbound flows (+US$37bn ytd), continued light positioning from global active mandates (289bps UW), inclusion-catalyzed Northbound flows (+US$28bn ytd), and potentially sizable property-to-equities capital rotation (GSe: Rmb331bn). These views drive our 100 end-18 target for MSCI China, implying 12% price return from current levels, and underpinning our continued Overweight China call in a regional context. Our 12m target on CSI300 is 4700, 14% upside.
We parameterize what we view as a sensible range of baseline return expectations based on our multi-factor-regression model, which encompasses China GDP growth, China inflation (deflator), Rmb exchange rate (vs. USD), and US monetary policy (FCI), all of which are important determinants of profits growth, liquidity flows, and equity multiples. This tool suggests that our economists’ baseline forecasts are corresponding to low-teen index upside for MSCI China in 2018. While we don’t base our views entirely on models, they allows us to stress-test our assumptions, and complement other approaches for forecasting returns as we discuss in the following sections.
Ok, so again, those are going to be moving targets. One thing to note about both onshore and offshore returns in 2017 is that they have been heavily skewed towards a handful of sectors and names.
Here’s a sector breakdown:
And here’s onshore and offshore returns decomposed to show you the outsized impact of the usual suspects (note Tencent and Alibaba in Hong Kong and Ping An and the above mentioned Moutai on the mainland):
So you might fairly say there’s a breadth issue there.
Whatever the case, here are Goldman’s targets visualized based on Friday’s close (the upside outlined above was based on November 16 closing prices):
Take all of that for what it’s worth and we’ll leave you with a truly amusing cautionary note from Goldman:
“8” carries a positive connotation in a Chinese context–luck, prosperity, and wealth. That said, the empirical evidence isn’t supportive of that notion for HK/China equities, which averaged -13% returns (HSI) in the years ending with “8” in the past 3 decades (a small sample though), due mainly to exogenous shocks.
Oh, and shout out to my old boss who actually wrote the following joke when this picture first started making the rounds during one of China’s harrowing selloffs a couple of years ago…