Necessary Elements of a China Turnaround

Key takeaways from this week's bulletin:

• Rebuilding Trust: Over more than three years, Chinese authorities have rolled out a slew of policy measures to bolster markets. Most recently, curbs on short selling, more ETF purchases, and incentives to boost consumer are being implemented in an attempt to increase investor confidence and reverse the direction of the market. These measures appear similar to what has been done before and that is unlikely to create a change in sentiment.
• What will it take: Improved governance and a boost to demand. New policies are needed to improve the profitability and investor friendliness of Chinese companies. Chinese regulators could take a page from the Tokyo Stock Exchange’s recent governance reforms and encourage dividends and buybacks, while implementing rules to prioritize shareholder interests. Stimulating consumer demand has also been missing in China’s arsenal thus far.
• For Investors: A tactical rally is possible given depressed sentiment and valuations, but a sustained recovery is dependent upon increased demand and improved corporate governance. If policymakers do steer towards this direction, we would prioritize growth sectors, with high cash levels and negative net debt, as these are the most likely to lift dividends and buybacks. However, if these issues are not addressed, investors are unlikely to be interested to return other than for tactical trading.

Potential Portfolio Implications

New policies are needed to reverse Chinese deflation and improve the long-term profitability and return on equity for Chinese companies. If better governance becomes an aim for listed companies based on policy directives, we would prioritize growth sectors including IT, healthcare, consumer staples, telecommunications services, and consumer discretionary, with high cash levels and negative net debt. We remain neutral on Chinese shares presently.