Things are never as good or as bad as they seem. That adage has generally served investors well. Ignoring the extremes of optimism and pessimism can spare equity buyers some painful mistakes — such as piling into tech stocks at the height of the dotcom boom — and may signal lucrative opportunities for the brave, such as during the depths of the 2008 global financial crisis. It’s worth asking where China’s stocks currently lie on this perceptual continuum, and whether markets are correctly judging the risks that confront them.
March has been a landmark month for the nation’s equities, with a two-week rout that wiped out more than $1.5 trillion of value followed by a rebound that was almost as spectacular. Prices recovered so quickly (after top policy makers stepped in to pledge support) that the plunge now looks like a flash crash. Yet the rally has only returned Chinese stocks to the depressed levels where they stood before going into freefall, with upward momentum having stalled in the past two weeks.
There’s plenty to worry about, no doubt. Many if not all of the factors that helped drive the MSCI China Index to less than half its February 2021 peak remain in place. A campaign to tighten regulation of internet platform companies has yet to conclude (even if Vice Premier Liu He has promised it will end soon). The real estate sector continues to weaken. The Covid-19 pandemic is resurgent, darkening the prospects for economic and corporate earnings growth this year. Chinese companies are still at risk of being delisted from U.S. exchanges. And above all, perhaps, there is the threat of China being embroiled in secondary sanctions resulting from its stance on Russia’s invasion of Ukraine.
Even so, it’s fair to ask how much of this negative overhang is already priced in. On a range of measures, the MSCI China is close to its weakest relative to the MSCI All-Country World Index in five years or more. By price-to-book ratio, the Chinese gauge is at its cheapest compared to the global measure in more than two decades.
Far from being tempted by such a valuation discount, international investors are behaving as if Chinese equities are radioactive. The country has been experiencing “unprecedented” capital outflows since late February, the Institute of International Finance said in a report last week. The exodus, shown in high-frequency data tracked by the IIF, is all the more notable because there has been no such move out of emerging markets as a whole.
