Amid power cuts and property curbs, can Chinese stocks bounce back?

Power constraints are expected to ease and property deleveraging risks remain low but investor sentiment is unlikely to change unless Beijing significantly eases its fiscal and monetary policies

Sylvia Sheng

Published: 2:30pm, 8 Oct 2021

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The third quarter lived up to its reputation as a more challenging time of the year for Chinese equities, with the CSI 300 Index down 6.8 per cent. Historically, the fourth quarter, in contrast, has mostly been a positive time for Chinese equities.

In the past 10 years, the CSI 300 has averaged gains of 7.4 per cent in the fourth quarter and was up in seven of the past 10 years. Will this period bring a better performance for China’s equity market after a rocky third quarter?

Concern about China’s slowing economic growth momentum is one of the main factors weighing on investor sentiment. This seems unlikely to change in the near term amid growth headwinds from power cuts and tight property policies.

Following sharper-than-expected slowdowns in July and August due to flood shocks and a resurgence in Covid-19 cases, the latest manufacturing purchasing managers’ index (PMI) points to further weakness. September’s official PMI fell below 50 and entered contractionary territory for the first time since February 2020, probably reflecting weaker production as a result of power constraints.

Power cuts in China were imposed in over 20 provinces last month due to electricity supply issues and tighter emissions controls. Thermal coal power generation, which accounts for more than half of China’s overall electricity production, has been constrained by surging coal prices amid tight supply.

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Domestic coal production has been weighed down by strict mining capacity controls since 2016 as well as disruptions to imports from Australia and Mongolia. Hydropower production, which was down 1 per cent year on year in the first eight months, added to the power supply problem.

However, the coal shortage may start to ease as Chinese policymakers have reportedly ordered state-owned miners to produce coal at full capacity for the rest of the year.

Another reason for China’s power constraints is its decarbonisation initiative. Given Beijing’s goal to reach peak carbon emissions before 2030 and carbon neutrality by 2060, it has been focused on reducing energy consumption and energy intensity (energy consumption per unit of gross domestic product).

However, the robust rebound in industrial activity following the Covid-19 crisis has made it hard for China to meet its decarbonisation targets so far this year.

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On August 17, the National Development and Reform Commission issued warnings to 20 provinces for failing to achieve their respective targets for reducing energy consumption and intensity in the first half of the year.

In an effort to meet their emissions targets, many local governments introduced curbs on electricity supplies to limit production for energy-intensive and high-emission sectors such as steel, cement and chemicals.

These tighter controls have weighed on production in recent months and the drag is likely to persist into the fourth quarter. But there could be some fine-tuning of the enforcement of environmental targets that will reduce the impact of power constraints on growth in the fourth quarter.

Moreover, tight property policies are having an impact on China’s growth and have hit property investment and home sales in recent months. Given policymakers’ focus on containing financial risks in the system, the likelihood of a disorderly deleveraging in the property sector seems low.

That said, more cautious sentiment could push up funding costs, which would in turn put pressure on investment in the sector and overall growth momentum.

However, Chinese policymakers are likely to roll out more easing measures in response to the recent growth slowdown, which could help support investor sentiment on China. On the monetary side, there is room this year for further cuts in the reserve requirement ratio, which sets the minimum amount of reserves a bank must hold and which cannot be lent.

While producer price index inflation is likely to remain elevated in the near term as production cuts in the materials sector put upwards pressure on prices, the potential of higher producer prices transferring into consumer prices is likely to be limited amid tepid consumption demand, and thus is unlikely to be a constraint on further monetary easing in China.

We are also likely see modest easing on the fiscal front, with an acceleration in the issuing of local government special bonds, which will support infrastructure investment growth.

China’s growth and policy outlook are key for the performance of Chinese equities in the fourth quarter. While the near-term growth headwinds are likely to affect China’s earnings outlook, we could potentially see more positive news from the macro policy side.

The pace of policy easing has been quite restrained so far compared to previous cycles. Any sign of a meaningful change is likely to boost sentiment and trigger positive reactions in the Chinese equities market.

Sylvia Sheng is a global multi-asset strategist at JP Morgan Asset Management