China Climbs Out of a Bottom

Chinese equity markets have gone from what many considered as “un-investable” at the start of the year to bull market territory. The extreme bearishness was not without merit, as a beleaguered real estate market and sputtering economy dragged many indexes down to pandemic-era lows, while memories of nationalized for-profit education companies and disappearing tech CEOs had not entirely faded. However, as is often the case, extremes in sentiment often work better as contrarian signals commonly found at important inflection points in the market.

Back in early February, we wrote a blog titled “Three Charts — Could China be Close to a Bottom” highlighting how both sentiment and oversold conditions were at extremes. In today’s blog, we provide a quick update on China and why we think this rally could continue.

Technical Setup Continues to Improve

The MSCI China Index — comprised of mid and large cap stocks available to international investors — has rallied off oversold levels and is now flirting with bull market territory, characterized by a 20% or greater advance off a bear market low. Technically, the index has also broken out from a head-and-shoulders bottom formation after reversing a declining price channel. Broad participation underpinned the breakout. Roughly one-third of constituents reached new four-week highs last week, while close to 50% are also above their 200-day moving average (dma), marking the highest percentage reading since August. Furthermore, the Percentage Price Oscillator (PPO) — a momentum indicator based on the relationship between two moving averages — provided additional validation of the breakout with a recent buy signal. In terms of upside, technical evidence suggests this rally could continue at least toward the 2018 lows (70) or even the 2023 highs (77).

Breaking Out from a Bottom

Source: LPL Research, Bloomberg 05/02/24
Disclosures: Past performance is no guarantee of future results. All indexes are unmanaged and can’t be invested in directly.

Follow the Money

After six straight months of sizable outflows, overseas investors started putting money back to work in China. Northbound flows that link Hong Kong and mainland stock exchanges in China have been positive for three straight months, pouring nearly 100 billion yuan into mainland shares since February. Important to note, China often uses offshore accounts to purchase state-owned enterprises when trying to boost local markets. However, this should come as no surprise given policymakers have pledged an array of support to help kickstart their sputtering stock market and economy.

Inflows Pour into China

Source: LPL Research, Bloomberg 05/02/24
Disclosures: Past performance is no guarantee of future results. All indexes are unmanaged and can’t be invested in directly.

Summary

China continues to make technical progress. Bullish momentum and broad participation imply this rally could have more room to run. And while there is a long list of well-telegraphed fundamental and geopolitical risks in China, signs of economic life are beginning to emerge. Manufacturing activity remained expansionary in April for a second straight month, while growth forecasts continue to get revised higher. There is also no shortage of policy support. Commentary from this week’s Politburo meeting suggests the economy could expect even more fiscal and monetary policy stimulus, something investors will hear more about during China’s third plenum meeting in July. LPL Research continues to favor U.S. markets over emerging markets and views the recent progress in China as more of a trading opportunity rather than a longer-term investment.