China’s stock market rally masks shaky pillars amid earnings downgrades, price cuts and policy headwinds

Zhang Shidong
·5-min read

Can China’s stock market sustain its advance in 2021 when expectations on corporate earnings and monetary policy support are weakening?

As capitalisation surpassed the US$10 trillion mark for the first time since 2015, analysts have turned less bullish on earnings prospects of the biggest companies traded on the Shanghai and Shenzhen bourses over the past five months.

The upgrade-downgrade ratio in the earnings of CSI 300 Index members has slipped to 1.36 in December from a peak of 1.68 in July, according to Bloomberg data. The revisions soured the outlook on banks and healthcare-related companies and favoured raw materials suppliers and technology providers. For S&P 500 members, the ratio eased to 1.99 from a high of 2.21 in September.

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That should trigger some concerns among money managers at a time when top policy makers in Beijing are signaling an end to ultra-loose monetary policy to counter the pandemic. Yet, a resurgence in global Covid-19 cases is casting a pall on the recovery outlook. The souring US-China ties have also eroded sentiments on Chinese stocks.

“There are split views on the market now and I don’t see a big catalyst that will further buoy up stocks significantly,” said Dai Ming, a fund manager at Hengsheng Asset Management in Shanghai. “We will see a normalisation of the monetary policy this year. It remains a big question as well, as to when the fresh wave of the pandemic will be put out.”

Analysts issued 169 upgrades and 124 downgrades on CSI 300 index members in December, the data shows. There were 392-to-233 changes in July. The ratio troughed in April with a reading of 0.47, before China began to contain the Covid-19 outbreak and lifted lockdowns across the nation.

The top three companies with the deepest earnings cuts over December were financial software provider Hundsun Technologies, airport operator Shanghai International Airport and insurer New China Life Insurance.

China’s economy likely has expanded 2 per cent in 2020, the only major one to grow through the pandemic globally, according to the consensus in a Bloomberg poll of economists. Growth may quicken 8.2 per cent this year.

The CSI 300 Index, which tracks 300 companies with a combined market value of 19.6 trillion yuan (US$3 trillion), rose 5.1 per cent last month. The full-year rally of 27 per cent followed a 36.1 per cent jump in 2019, the first back-to-back win since 2015.

Equity strategists at some of the nation’s biggest brokerages including China International Capital Corp and Huaxi Securities are upbeat about further stock upside in 2021. The bull run could persist with stronger fund inflows, according to Citic Securities.

Inflows will probably reach 2 trillion yuan this year from 1.5 trillion yuan in 2020 as individual investors pour their household savings into new mutual funds, Haitong Securities said. The number of retail accounts rose 10 per cent to 175 million in 2020, according to data published by China Securities and Depositary Clearing.

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China’s economic rebound could present headwinds too.

For one, higher costs of raw materials could put corporate earnings and ratings under pressure. Crude oil futures have risen 20 per cent over the past three months, while copper jumped 16 per cent and iron ore 12 per cent. Since June 30, they have risen by 24 to 37 per cent.

“Rising raw-material prices are squeezing the profit margin of the midstream and downstream industries, such as manufacturing,” said Wang Chen, a partner at Xufunds Investment Management in Shanghai. “It will be quite difficult for these industries to raise product prices immediately in the early stage of the economic recovery.”

For another, China has not shied away from rocking the market to rein in excesses, such as canning the record-breaking Ant Group stock offering and the subsequent clampdown on Internet-platform operators. For the first time, the central bank also slapped limits on bank lending to the property sector to prevent systemic risks, Bloomberg reported on January 1.

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The domestic health care sector is also bracing itself for a potential slump in earnings. The industry last month agreed to a 51 per cent average price cut to get 119 drugs into the reimbursement list under the national insurance scheme. Prices of coronary stents crashed 93 per cent in November.

The government will also centralise its drug procurement and quality testing systems for 2021 to end profiteering. The system will grant bigger purchase orders to suppliers with lower prices. Half the 4,000-odd industry players could be out of business in five years, according to Citigroup.

For Dai at Hengsheng Asset Management, the promises of economic recovery should have encouraged company CEOs to borrow and expand their businesses. That is still not evident as China’s 12-month loan prime rate has remained at 3.85 per cent, unchanged for the past eight months.

“The unchanged interest rate indicates a lack of strong confidence in the economy and conviction on sustained earnings recovery,” he said.

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