Place your bets on Chinese stocks to beat global peers in the next six months on policy divergence, BCA Research says

Chinese stocks, among the worst performers in 2021, are likely to outperform global peers within the next six months, offering protection from a sell-off stoked by higher US Treasury yields, according to BCA Research.

Investors should favour stocks in the MSCI China and MSCI Hong Kong indexes over global benchmarks as a divergence in monetary policies in China and the rest of the world creates room for outperformance, the Montreal-based said in two new tactical trades on January 19.

“Chinese investable stocks are in oversold territory and is likely to rebound in the near term in both absolute and relative terms” and offer good value, strategist Sima Jing wrote in the report. “The Hong Kong equity index is also technically oversold. Since the composition of the index has become more defensive, it is likely to outperform in risk-off phases.”

Both indices have outperformed their US and global peers in the opening weeks this year, according to Bloomberg data. The MSCI China Index slipped 0.4 per cent while the Hong Kong index gained 2.9 per cent, damaged by regulatory crackdowns while US and global stocks lost more than 4 per cent.

Last year, they fell by 24 per cent and 6.4 per cent respectively, while the S&P 500 and MSCI World Index rallied for a third year to record highs.

BCA Research made six correct calls out of its eight trade recommendations involving the broader country and sector allocations, including a decision in March to downgrade MSCI China just before a trillion-dollar rout sparked by a clampdown on internet-platform operators.

Higher bond yields in the US have ignited a rotation out of US technology stocks this month amid signals from the Federal Reserve on faster tightening pace from next year. While Chinese technology stocks could also suffer, losses may be cushioned by policy easing momentum in the Asian economy, she added.

The MSCI Hong Kong could outperform global indices due to the bigger presence of insurance and financial stocks, said BCA Research. Financials take up 46 per cent of the 35-member index, followed by property with 20 per cent, according to MSCI data. AIA Group is the single biggest component with more than 25 per cent weighting.

“Insurance and diversified financials subsectors are less vulnerable to escalating short-term interest rates compared with property stocks,” said Sima. “The defensive nature in the MSCI Hong Kong Index will support its performance relative to industrial- and tech-heavy emerging markets and global equity indexes.”

Besides, the strength of the US dollar would also have a material impact on Hong Kong stocks, BCA Research said. Tighter US monetary policy and higher bond yields could strengthen the US currency and the pegged Hong Kong dollar, underpinning stock returns.

Deutsche Bank’s private banking unit is taking a neutral stance for now, expecting the second quarter as the turning point for Chinese equities. Covid-19 restrictions based on its zero-tolerance policy are headwinds to the economy.

Despite some degree of monetary and fiscal policy easing recently, “policy tightening in certain sectors could continue in line with the government’s longer-term objective of common prosperity,” said Jason Liu, Asia head of chief investment office at Deutsche Bank International Private Bank.

BCA Research remains underweight on Chinese equities on a cyclical basis beyond six months. It’s holding back an upgrade on the market because of a slowing economy, high odds of a sharp contraction in corporate earnings and ongoing regulatory and geopolitical risks.

Current policy easing measures are insufficient to revive China’s slowing economy, Sima wrote in the report, even with the central bank cutting its policy loan rates on Monday, for the first time in almost two years.