What are the headwinds facing China stocks?

China stocks are experiencing mounting headwinds, with an energy crisis adding to the negative sentiment surrounding the country’s economy. The economy seemed it would outperform rivals at the start of the year.

Power consumption curbs on account of emission targets and problems with coal supplies have led to power shortages across China. It has hindered production at factories, including those supplying Tesla [TSLA] and Apple [AAPL].

China has been affected more acutely by the global energy crisis. As fuel prices skyrocketed power plants cut coal purchases. Now they have run out and are reluctant to buy more as prices remain high.

Research from Goldman Sachs suggests the resulting power consumption constraint in the near future is likely to hurt overall growth, with the investment bank downgrading the country’s growth prospects to 7.8% for the year compared with 8.2% last year.

“A relatively new, but tightening, constraint on growth comes from increased regulatory pressure to meet environmental targets for energy consumption and energy intensity,” the Goldman Sachs economists wrote in the research report.

“A relatively new, but tightening, constraint on growth comes from increased regulatory pressure to meet environmental targets for energy consumption and energy intensity” - Goldman Sachs economists

 

According to Goldmans, the resulting production cuts and less fiscal support will lead to slower economic growth in the final two quarters of 2021. The country already recorded weak manufacturing data in September. Manufacturing activity in China suffered its first contraction since the pandemic started in September, as power shortages and a slowdown in China’s economy came to bear. Figures from China’s manufacturing purchasing manager’s index released 30 September came in at 49.6 for the month - below the 50-point threshold that separates contraction from expansion. Foxconn [XTAI: 2354], which supplies components for iPhones, saw its share price drop as much as 2.6% the day after the weak economic data was announced.

S&P Global Ratings too lowered its GDP forecast for China, adding that the weakening Chinese economy could spill across south-east Asia. The ratings agency cut its growth projections by 30 basis point 8%.

 

Headwinds mount for China stocks

China stocks are facing a raft of economic headwinds, some seemingly self-inflicted. For instance, Beijing’s clamping down on the tech sector, problems in its huge property sector after the Evergrande debacle, and continued outbreaks of the Covid-19 Delta variant. 

“Economic growth in the fourth quarter will likely slow further without a change of government policies, and the pace of slowdown may pick up,” Zhiwei Zhang, chief economist at Pinpoint Asset Management, told the Financial Times.

The Evergrande saga has also spooked the Chinese property stocks, China Garden Holdings [2007.HK] has fallen 7% over the past month, Vanke is down just over 2%, both of which have managed to regain some losses following news that Evergrande was about to default at the end of September. Evergrande is still down around 30% for the month. 

“Economic growth in the fourth quarter will likely slow further without a change of government policies, and the pace of slowdown may pick up” - Zhiwei Zhang, chief economist at Pinpoint Asset Management

 

The worst hit are China tech stocks, which have taken a beating this month, according to our thematic screener. The investment theme is down over 10% as of 1 October. The worst performers from those tracked are Bilibili (down 24.13%) [BILI], Tencent Music [TME] (down 21.51%) and Alibaba [BABA] (down 16.37%). Of the 16 stocks and ETFs covered by the screener in the China tech bucket, only Autohome has gained, up merely 1.72% on the month.

 

Saving Grace

It’s not all bad news. China Petroleum & Chemical Corp. [SNP] and PetroChina [PTR] - two of the biggest companies in China - are both trading up on the month, having shrugged off the weak PMI data.

Looking wider, the Hong Kong-based Hang Seng index is down 5.6% over the month, while the Shanghai SE Composite Index [000001.SS] is trading flat. For comparison, the S&P 500 has dipped 3.6% over the same time frame.

The Hang Seng’s losses, however, grow when looking at its performance since the start of the year, with the index down 13%, reflecting the increased scrutiny of tech stocks listed on it.

All in all - the investment case for China is clearly riskier than it was at this time last year. However, other nations are currently undergoing their own energy problems - the UK for example. An end to US and European central bank support to the economy is likely to dampen sentiment in markets globally. So there may be opportunities in China but investors will need to cherry-pick.