Strategy of betting on Chinese value stocks may be losing its winning edge, says CICC

·4-min read

Investment banks from China International Capital Corp (CICC) to Founder Securities are becoming sceptical about value trades, one of the most successful strategies for Chinese stocks so far this year, questioning whether the ploy will work for the rest of 2021.

Bets on the likes of Bank of China, Country Garden Holdings and China Mobile have rewarded investors with an average return of 27 per cent in 2021, the second most successful tactic after chasing dividend names, according to Bloomberg data. Buying into growth stocks such as Tencent Holdings and Sino Biopharmaceutical, a successful trade that returned 15 per cent last year, has incurred an average loss of 21 per cent year-to-date, the data shows.

While the sector rotation has largely been fuelled by the dramatic changes in China’s regulatory landscape, the frenzy for value trades has prompted some caution from analysts who say the gains in share prices may have already overshot fundamentals.

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“The run-up on value stocks is most probably a relief rally and the chance is low for a reversal,” said Liu Yang, an analyst at Founder Securities. “The banking and property industries are in the mature stage so the driver for earnings growth and its sustainability are very limited. The main trade may rotate back to tech growth stocks after a brief rebalance.”

Value stocks have been back in favour after Beijing’s regulatory crackdown on the fastest-growing industries from e-commerce to after-school learning has prompted traders to seek safe haven assets. Even after the rally, the banks and property developers on the Hang Seng Index are trading at a 40 per cent discount to book values on average, according to Bloomberg data.

Just a year ago, value trades were a redundant strategy among investors. Buying into value stocks incurred an annual loss of 31 per cent in 2020, when traders capitalised on the record amounts of credit unleashed by the central bank to combat the pandemic to boost their holdings of growth names that are more sensitive to liquidity.

An economic recovery from the damage of the pandemic this year has fuelled reflation bets, bolstering cyclicals such as banks and developers whose earnings strength is linked to economic swings. Chinese developers have got an additional boost thanks to optimism that a government rule capping the premium on land sales at 15 per cent will protect margins and after China Evergrande Group rolled out rescue plans to ease its cash crunch.

CICC sees the boom in value trades as transitionary, pointing to the tumultuous sell-offs of tech stocks that has already made their valuations appealing. Tencent is trading at 25 times estimated earnings for this year, compared with its five-year average of 35 times, while the multiple for Alibaba Group Holding, whose shares dropped to a record low in Hong Kong last week, is 18 times, according to Bloomberg data.

“We believe leading growth names, though sensitive to regulatory changes in the near term, are becoming increasingly attractive,” analysts led by Wang Hanfeng at CICC wrote in a report. “The rise in US yields might continue, especially when the Fed starts to hint at tapering, providing room for a catch-up and temporary outerperformance of value laggards. But over a medium-term horizon, growth [names] might continue to prevail against the backdrop of moderating [economic] growth.”

Not everyone agrees. UBS Group cautions against buying China’s internet stocks on the dip, believing the government’s regulatory curbs are not going to recede any time soon and there is a low chance that the central bank will further loosen monetary policies.

Tencent warned of slowing profit growth ahead after its quarterly results release last week, because of the impact of the clampdown.

Historical data shows that placing bets on growth stocks has been a winning strategy in the long run. Investments in growth names on the Hang Seng Index have fetched a return of 53 per cent over the past decade, while buying into value stocks has delivered a loss of 24 per cent, according to Bloomberg data.

The consensus that China’s growth has already peaked and will decelerate, coupled with the tightening of measures against the property market, foreshadows the stalling of the value trade, according to Avic Securities. The fact regulators have called for banks to cede part of their profits to support the economy means a narrowing net interest margin, the major source of revenue for commercial lenders.

“It’s hard to see fundamentals improving in banks and developers,” said Dong Zhongyun, an analyst at the brokerage.

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