Sailing through the Storm

Sailing through the Storm

Geopolitical tensions remain heightened with the Russia-Ukraine conflict exerting additional pressures on financial markets. Although the conflict zone is miles away from Hong Kong and China, the stock market still feels the brunt with increased risk aversion and higher inflation expectations, which have also pushed oil prices to multi-year highs. The stability of global financial and payment systems could be disrupted by sanctions imposed on Russia.

Meanwhile, the side effects of tough social-distancing measures in Hong Kong to curb the Omicron-variant  outbreak are visible on every street corner. According to the Hong Kong Retail Management Association, its members expect foot traffic in shopping malls to fall by at least half – a situation that we are witnessing everyday. Retailers also estimated that sales revenues could drop anywhere between 20-60%.

Remain positive on equities in the longer term

Despite all the short-term challenges, there are many reasons to hold a longer-term positive view on equities: a) robust earnings and cash flow growth, supported by b) fiscal stimulus to spur economic growth (remember Beijing’s plan to “front-load infrastructure investment”?), c) loosening of monetary policies by the PBoC, d) high levels of accumulated savings, and e) a forthcoming boost from the elimination of Covid-related mobility restrictions globally.

We continue to advise investors to navigate the storm by appropriate sector rotations and prepare for a cyclical rebound later this year.

What to watch out for in March 2022

The Two Sessions – This paramount annual political event in China will commence on 4 and 5 March this year. The 13th National Committee of the Chinese People's Political Consultative Conference (CPPCC) will open its fifth annual session in Beijing on 4 March 2022, while the 13th National People's Congress (NPC), China's top legislature, will open its fifth annual session the next day. Major economic and diplomatic policies will be laid out during the meetings:

• GDP growth target – Premier Li Keqiang is expected to deliver the Government Work Report at the opening of the NPC session 5 March 2022. It will be an ideal occasion to announce the GDP growth target for 2022. Beijing is expected to maintain at least 5% GDP growth (the target for 2021 was “above 6%”).
• Fiscal stimulus directives – The PBoC has undertaken several rounds of monetary easing, including interest rate cuts and reserve requirement ratio reductions, to “stabilise the economy” since December 2021. It is expected that the central government will issue directives to departments at the state and provincial levels to achieve a “reasonable growth range”.
• Taiwan and defense budget – an indication of Beijing’s assessment of national security. The figures are even more sensitive this year, given that the Chinese Communist Party will elect its top leaders at the 20th National Congress of the Communist Party of China in late 2022, not to mention the recent Russia-Ukraine conflict.
• Peak of earnings season – The Hong Kong stock market is entering the peak of the results reporting season. Given the renewed global Covid outbreak and inflationary pressures in 2H21, we have the sense that earnings expectations are not too high. FY2021 earnings surprises can be a catalyst to the market. However, all ears are on companies’ guidance for 2022.

Notable developments in selected sectors

1) China internet regulatory news flows

The China internet sector has been volatile in February 2022 (see Chart 1) in response to various negative regulatory news flows:

i. Food delivery operators were requested by regulators to lower services fees charging restaurants. The National Development and Reform Commission also asked the operators to provide progressive fee discounts to merchants in medium-to-high pandemic risk areas.

ii. Rumours on stricter gaming content regulations and freezing of game approvals for 2022, though the National Press and Publication Administration and the China Audio-video and Digital Publishing Association immediately dismissed the reports.

iii. Unconfirmed report that Chinese authorities had notified state-owned banks to kick off a fresh round of checks on their financial exposure to the financial arm of an internet giant.

iv. The China Banking and Insurance Regulatory Commission warned about illegal fundraising related to the Metaverse.

These developments could trigger another round of investor debate on the long-term earnings implications for the internet giants as they have been tasked to do “national service” in pursuit of common prosperity. However, we note that in the case of food delivery operators, the relief measures appear to be part of the government’s broader attempt to accelerate recovery of Covid-impacted industries, rather than specifically targeting food delivery or internet platforms. While there may be a risk that ecommerce platforms are asked to do the same to support smaller merchants, we think any such measures will likely be temporary.

While the China internet sector will remain volatile and sensitive to regulatory news flows in the near term, overall we believe that new regulatory framework and policies have largely been defined (e.g. antitrust, consumer protection and data privacy, cybersecurity), and 2022 will be a year more focused on regulatory enforcement of existing policies, and hence should present less negative surprises to the sector.

2) HK’s new property-related policies

The HK Government’s budget for 2022-23 proposed several property-related policies that will shuffle the market in our view. In short, we think the policies are good for developers but bad for landlords, and overall a mixed bag for the HK property sector.

• What’s good – The cap on property value eligible for an 80% loan-to-value ratio (LTV) mortgage will be increased from HKD10 million to HKD12 million, and that for a 90% LTV mortgage from HKD8 million to HKD10 million. This step-up should improve affordability of small- and medium-sized residential properties, which would in turn spur sales.
• What’s bad – An unprecedented measure was announced to temporarily take away property owners’ rights to collect rent or not provide services to tenants of specified sectors. Tenants can delay rental payments by 3 months, which could be extended to 6 months.

We think the new policies will help underpin residential property prices (private domestic property price fell for four consecutive months from October 2021 to January 2022, according to the Hong Kong Rating and Valuation Department), while shifting power from retail property landlords to tenants. We favour property developers with strong residential property project pipelines over the retail and office landlords.

3) Offshore Renminbi Hub

Also during the Budget address, Financial Secretary Paul Chan disclosed that the regulators have completed the feasibility study on allowing stocks traded via the Southbound Trading of Stock Connect to be denominated in RMB, and put forth recommendations on implementation details. The Hong Kong Government will roll out supporting measures to increase the liquidity of RMB‑denominated stocks. Banks and securities brokers are deemed to benefit from higher trading volume and a larger pool of investment funds.

4) Materials inflation and Asia-based producers

Rising energy, commodity, labour and transportation costs (see Chart 2) have fuelled higher inflation in many countries, and it is challenging to assess how long this inflationary environment will last. The Russia-Ukraine conflict has worsened the near-term outlook for global commodities supply, as Russia is a major producer of palladium (37% of the world), natural gas (17%), gold (10%), crude oil (10%), platinum (10%), met-coal (8%), nickel (7%), aluminum (6%) and a wide variety of agricultural commodities. Ukraine is a major producer of neon gas, which is a key material in semiconductor equipment.

We believe Asian producers, especially in sectors with excess capacity and lack of brand power, may bear the bulk of the margin pressures amid the rise in both commodity and labour costs. Airlines, consumer staples, autos, paper manufacturers, building products and equipment makers are most exposed to input cost inflation in our opinion.