Why is Chris Wood of Jefferies turning bullish on China equities?

Chris Wood has hiked exposure to the dragon nation in his Asia Pacific ex-Japan relative-return portfolio by two-and-a-half percentage points to maintain a 'Neutral' weighting

Christopher Wood, global head of equity strategy at Jefferies is turning bullish on China equities and believes China is the story of the moment in the emerging market equity space as things stand.

He has hiked exposure to the dragon nation in his Asia Pacific ex-Japan relative-return portfolio by two-and-a-half percentage points to maintain a ‘Neutral’ weighting. This hike in exposure, Wood said, will be paid for by reducing the weight in Indonesia and Korea by one-and-a-half percentage points and one percentage point, respectively.

China, Wood said, enjoyed its biggest monthly outperformance in April in an Asia ex-Japan and emerging markets (EM) context since December 2022, as the stock market benefitted from a correction in other markets and a further rally in Shanghai.

“There is the potential for this stock market rally in China to continue, which could lead to further relative outperformance, most particularly if other markets correct again on a lack of Federal Reserve easing concerns,” he wrote in his latest weekly note to investors, GREED & fear.

Meanwhile, MSCI China outperformed MSCI Emerging Markets and MSCI AC Asia ex-Japan by 6.2 per cent and 5.3 per cent, respectively, in April. MSCI Emerging Markets index (ex-China), on the other hand, declined by 1.8 per cent.

As for the Shanghai A shares, the Shanghai Composite index rose by 2.1 per cent in April and is now up 18.7 per cent from the low reached on February 5.

This outperformance, Wood said, pushed him to raise the weighting in China in the Asia Pacific ex-Japan relative-return portfolio.

 

In US dollar terms, however, MSCI China, is still down 54 per cent from the high reached in February 2021. After the recent market rally, the MSCI China is now trading at 1.16x price-to-book as at the end of April, compared with a peak of 5.33x in October 2007.

“Jefferies’ Quantitative Strategy team’s price-to-book model suggests that, should history since 2002 repeat itself, MSCI China has a further upside of 35.4 per cent over the next 12 months from the level at the end of April, with close to a 100 per cent hit rate of delivering positive returns,” Wood said.

Share buybacks and dividend payout

The bull-case in China, Wood believes, is tactical rather than structural. "This is because the continuing high level of real interest rates is self-evidently deflationary even if that had been discounted to a large extent by the outperformance of dividend stocks in China and a roaring bull market in long-duration government bonds," he said.

A surge in China equities in the last few months has also seen a steady rise in share buybacks by Chinese companies. China A share companies, reports suggest have bought back shares worth Rmb 73.2 billion in the first four months of this year, up from Rmb 21.4 billion in January - April 2023 period.

“The total payout ratio (dividend plus buybacks) for MSCI China is now about 42 per cent, a record high since 2010, while the percentage of companies doing buybacks also rose to a record 34.4 per cent over the past 12 months as at the end of April,” Wood said.