China's 2023 economic rebound has relied heavily on a domestic consumption recovery, as life normalizes and pent-up demand is released. (UBS)

The Hang Seng China Enterprises index has declined around 5% week-to-date, while the Nasdaq Golden Dragon China Index focused on ADRs fell 4.9% on Tuesday. The yuan has eased to 7.19 against the US dollar, marking a new seven-month low.

The People’s Bank of China on Tuesday trimmed both its one-year and five-year loan prime rates (LPR) by 10 basis points, in line with consensus forecasts but more modestly than some had hoped. US Secretary of State Antony Blinken’s visit to Beijing offered only limited relief, with the headline agreement simply to talk more. Tensions are already back in the headlines after an off-the-cuff remark from President Joe Biden drew a rebuke from China’s foreign ministry.

A reality check on big bang stimulus hopes is not surprising—we warned of precisely this risk last week. But we don’t think this is the only positive driver to consider:

No “big bang” stimulus, but more policy support is coming. While the rate cuts may be more marginal than hoped, the difference is minimal in terms of economic impact, especially given already cautious home-buyer sentiment. What it does confirm is a policymaker tilt to more proactive support. Behind the scenes, Bloomberg and the Wall Street Journal have reported more stimulus is under discussion, with renewed auto sector measures the latest top-down support for both consumption and output. We anticipate more targeted support for consumption, housing, and infrastructure. Another 1–2 cuts to the reserve requirement ratio (RRR) and one more medium-term lending facility (MLF) rate cut may materialize if warranted by incoming data. Investors can expect more clarity from the Politburo meeting at the end of July.

China’s recovery has not been canceled. China's 2023 economic rebound has relied heavily on a domestic consumption recovery, as life normalizes and pent-up demand is released. While May retail sales came down a notch, weaker consumer sentiment is only partly to blame, with positive base effects leveling off too. The service consumption recovery remains largely on track, with domestic flights and hotel spending near 2019 levels. The property and industrial recovery remains more fragile, with pressure evident in industrial output and fixed asset investment. We think incremental stimulus in the months ahead is likely to focus on weak spots, helping to sustain a GDP growth rate this year somewhere between 5% to 5.5%.

Valuations are attractive, and earnings upgrades can be expected. With the early 2023 recovery optimism behind us, and now some realism on both geopolitics and stimulus, markets remain in search of a sustainable catalyst. Pressure on equities has brought MSCI China's forward price-to-earnings ratio near 9.3 times, or just around 16% higher than last October's crisis trough. First-quarter results on balance came in above expectations, and company guidance has room to improve if more proactive stimulus measures materialize. We forecast 14% China corporate earnings growth this year.

So, we stay most preferred on Chinese equities within our Asia strategy, and on emerging market equities in our global strategy—China equities account for around 30% of the MSCI EM index. Within China equities, we suggest a barbell strategy favoring recovery and consumption plays, including consumer and internet names, as well as material and industrial names that can benefit from strong infrastructure investment this year. We also favor indirect beneficiaries like insurance, utilities, and banks that should stay defensive amid any significant market volatility. We think the yuan—now highly inexpensive on a real effective exchange rate basis—should partially reverse its slump against the dollar in the second half of the year.

Main contributors - Solita Marcelli, Mark Haefele, Jon Gordon, Kathy Li, Eva Lee

Content is a product of the Chief Investment Office (CIO).

Original report - Reality check, but China stocks can still rise, 20 June 2023.