Patience through Bumpy Final Leg of Bear Market
Comment of the Day

May 11 2022

Commentary by Eoin Treacy

Patience through Bumpy Final Leg of Bear Market

Thanks to a subscriber for this report from Morgan Stanley which may be of interest. Here is a section.

Eoin Treacy's view

Here is a link to the full report and here is a section from it: 

MSCI China could be approaching the late stage of a bear market after a 14- month drawdown (51% down in absoluteterms,32% relative to MSCI EM since Feb 17,2021), but the potential final leg is likely to be bumpy: Broader economic drag due to Omicron spread and subsequent restrictive measures imply downside-skewed earnings pressure and a capping effect of potential immediate China policy easing. Meanwhile, external concerns, such as QT overlapped with a gloomier global outlook and extended geopolitical tension, could also curb near term re-rating opportunity. Our June 2023 base case index targets are a respective 70; 21,500; 7,330; and 4,300 for MSCI China, Hang Seng, HSCEI, and CSI300, suggesting 9%, 7%, 8%, and 10% upside vs. the 6 May market close.

We take the latest Politburo meeting signals positively, but would stay equal weight on Chinese equities within the global EM framework in the near term. We welcome recent policymakers' reference to easing measures stepping up, with a focus on infrastructure boost, potential relaxation of property purchase restrictions and escrow fund access, and the positive role capital plays/completion of regulatory reset. That said, our China equity framework suggests that the policy positives could be discounted by the aforementioned factors, with downside risk more front-loaded in the near term.

COVID cases are finally coming down in Shanghai which is positive news for the domestic economy. China remains exposed to the risk of further outbreaks because of the size and age of the population and the reluctance to be vaccinated. That holds out the prospect of continued lockdown phases for the foreseeable future. That’s a recipe for volatility.

The issues with the property sector continue to metastasize. Sunac, the third largest developer by sales, has failed to make a $29.5 million coupon payment at the end of the grace period today. That’s technically the first offshore default. This Reuters article carries some additional detail. 

A default could trigger the cross-default provisions on all of the developer's $7.7 billion worth of bonds in international capital markets.

Sunac has missed four dollar coupon payments totaling $104 million since April, with three of them still in grace periods.

The firm said in March it was discussing debt solutions with offshore creditors after downgrades by global rating firms, as well as seeking payment extensions with onshore bondholders.

The question for investors is whether this development wlll prompt more overt stimulus action from the government. They may view success in containing the Shanghai COVID breakout as sufficient to fuel a relief rally in consumer activity. Alternatively, this may allow officials to focus on something other than infection rates.
The Hang Seng China Enterprises Index (H-Shares) is attempting to put in a higher reaction low but still has lower highs. A sustained move above 7500 would break the downtrend.

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