China stocks have made a remarkable recovery since the lows in October 2022 with many stocks doubling since. The Hang Seng Index (HSI) went up more than 50% since the lows recorded in Oct 2022 before coming down a notch.
The inevitable question arises then on whether it is time to take profit or is there more upside to come.
Here are 5 considerations on whether you should take profit now.
1) Economic conditions
The Chinese economy has been lacklustre in 2022 due to the lockdown policies. Since the reopening was announced, the Chinese Yuan has strengthened to a high of USD/RMB 6.74 from 7.30 in October. Recent datasets have also started looking more positive with January 2023’s Caixin Services Purchasing Manager’s Index (PMI) expanding for the first time in 5 months.
This PMI index tracks the health of variables such as sales, employment, inventories and prices and is an indication of the prevailing direction of economic trends in the manufacturing and services sector.
As the good news has only just started coming in, China is wary of any potential let up and is still carrying out expansionary fiscal and monetary policies.
Recent news have indicated that China’s policymakers are planning to increase support for domestic demand this year but they are likely to stop short of coming up with a big stimulus injection on direct consumer subsidies, instead keeping their main focus on investment. This is a familiar playbook of policies and provide support to key industries as well as splurge on infrastructure.
In November 2022, China also rescued its property sectors with initiatives such as extending developers’ outstanding bank loans and trust borrowings due within the next six months for a year.
In December 2022, China’s CPI rose 1.8% YoY, up from 1.6% the previous month, levels that are much lower than most other major economies.
On the other hand, the US is faced with issues such as high inflation, a slowing economy as well as a hawkish federal reserve that is bent on curbing inflation through higher interest rates and a reduction in the size of its balance sheet.
The US is the world’s largest economy, as the saying goes, when the US sneezes, the world catches a cold. Therefore, while China is on a recovery track, this could be stifled by the economic growth slowdown in the rest of the world.
2) Volatile regulatory and political conditions
China had previously signalled the end of its regulatory clampdown over the tech and other industries and has made an about turn in some instances, such as by coming out in support of the digital economy.
The Chinese leadership has asked that the country’s Big Tech firms play a full role in leading economic growth, creating jobs and engaging in international competition, in the strongest signal yet that a two-year period of intense scrutiny is almost over.
Jack Ma, who is the face of Alibaba and the first to be subjected to the regulatory clampdown has even been spotted making appearances in various parts of the world, fuelling more exuberance. At the same time, Jack Ma also ceded control of Ant Financial, another indication of a resolution of the very first issue igniting in the regulatory clampdowns.
On 18 Jan 23, China’s Vice Premier Liu He and US Treasury Secretary Janet Yellen has also met with a positive outcome, agreeing to enhance communication.
On the other hand, the Chip war is continuing as there is speculation that Japan and Netherlands will be joining US in its ban on exporting certain tech such as advanced chip making equipment to China.
Previously, ASML already cannot ship its most advanced extreme ultraviolet lithography systems to China because it could not obtain an export license from the Dutch government.
Should there be additional restrictions against China, this could further set back China’s semiconductor chip ambitions and therefore this additional ban will not sit well with the Chinese government.
3) Russia Ukraine conflict continuing
The Russia Ukraine conflict caused the HSI to drop nearly 20% from 24 Feb 22 when the invasion officially commenced to 15 Mar 22. Subsequently, as the conflict persisted, it has acted as an anchor to HK stocks.
As the conflict has not been resolved, with the US and Germany announcing their intent to send tanks into Ukraine in recent weeks, there is a significant possibility of retaliation and escalation by Russia.
It is rumoured that Putin has invited President Xi to Moscow in Spring and while the Chinese government has not confirmed the visit, market watchers are hopeful that President Xi can influence Putin to quickly resolve the Russia Ukraine conflict.
4) Uncertain 2022 earnings season and 2023 forecast
As China was stuck in a lockdown in 2022, market watchers do not expect much for the 2022 earnings season as not only were companies affected by the consequence of the lockdowns but many of the large companies also had to contribute to support the government’s initiatives.
For example, Alibaba’s Ele.me and Tencent had cut its commission fees for small and medium enterprises. Tencent also reduced fees on money withdrawals for individual users.
Meituan had also reduced or waived its commission fees and increased manpower in cities that faced lockdowns.
Property developers and REITs were affected by the lockdowns as well as the debt crisis as they were not only affected operationally but also in terms of availability of financing.
Hence, market watchers will be keenly looking for signs of a structural bottom as well as positive outlook for the upcoming months. For investors who are unsure of the strength of China’s rebound, they may choose to take profits before the earnings are released.
5) Technical analysis may be the key
The technical charts were overbought in the near term before the correction began.
Looking at the HSI chart, in the short term it seems to be sitting on the lower bound of the uptrend channel and seems to be at risk for further downside in the short term. The index is also sitting on the 20MA while the RSI has fallen from overbought levels. The recent high of about 22,700 points also marks the third time that the index has failed to break through this resistance level.
Looking at the broader picture, it is clearly still in an up trend.
Looking at Alibaba’s chart in the shorter term, the stock has broken down and is about to test the first Fibonacci retracement level as well as at risk of breaking down from its uptrend channel. Alibaba has also broken through the 20MA, and its RSI has come down from overbought levels.
Similarly to the HSI, Alibaba was also unable to break through the resistance levels for the third time but looking at the broader picture, it is still in an up trend.
Closing statements
The strength of the Chinese economy and end of Chinese regulatory crackdown are reasons why the HSI recovered significantly from the lows.
On the other hand, there are worries over the other major economies, the Russia Ukraine conflict as well as US’s regulatory actions against China.
The uncertainty over HK stocks’ FY22’s earnings as well as its FY23 outlook is also an overhang for the immediate term.
Even though the HSI is up 50% from the lows recorded in November 2022, the current levels are still significantly below the high for HSI was approximately 30,600 points recorded in February 2021.
Even at current levels, the recovery is less than half of the total decline, which makes the answer to whether one should take profit or hold on all the more difficult.
Looking at the technical charts, it seems like the short term trend has turned while the longer term trend still remains intact at this juncture.
