China's Markets Will Recover From Covid-19

For investors in Chinese stocks, the main question on their minds lately is when and if Beijing will finally ease up on its strict Covid-19 and property-sector control measures. There are some signs that real change could finally be on the horizon.

However, the more pressing question remains: how profitable is investing in the Chinese market likely to be over the coming decade, even assuming the best case scenario for property and Covid-19?

After a couple of years of decline, Chinese shares have rebounded this month. The MSCI China surged 21% in November, as Beijing fine-tuned its strict pandemic curbs and stepped up support for the struggling property sector. Even after the rally, the index has still lost more than half of its value since early 2021, basically wiping out all the gains in the past decade.

A quick turnaround in China’s Covid-19 policy or property market is unlikely. The recent surge in Covid-19 cases and the resulting lockdowns across the country are a strong reality check for the wide-eyed optimism that was evident in some press and brokerage reports earlier this month. But sentiment that the worst is over will nonetheless likely continue to drive the market in the coming months—especially given how battered Chinese stocks really are. The Hang Seng China Enterprises Index trades at nine times forward earnings according to FactSet, hovering just above its lowest levels in decades.

The trading multiples for Chinese stocks have dropped, but that doesn’t answer the question of how much investors should pay. According to Citi, earnings per share for stocks in the MSCI China Index have fallen 31% from their peak last October, with real estate, technology and consumer stocks leading the decline. An eventual reopening of the economy will help boost earnings, but that will likely still be months away.

Long-term earnings growth in China has lagged behind other countries for some time, and there are now new reasons to believe this trend will continue. According to Citi, earnings per share for the MSCI China Index have been flat since 2010, despite strong economic growth. Over the same period, earnings per share for the MSCI USA Index have grown by 9% per year.

The earnings growth of traditional Chinese stocks like state-owned energy and telecom companies has slowed, but they still make up a large part of the Chinese stock index. The internet sector was expected to replace those stolid stocks, but it now faces structural headwinds following the past two years of regulatory assault.

It is unclear what could rise up to take the place of China's current industries. The country faces an uphill battle in the extraordinarily capital-intensive chip sector. And while it has strong contenders in the electric-vehicle and battery space, those industries are still in their infancy and could face further technological disruption from abroad.

It is far from clear that a rebound in China's economy will translate into strong earnings growth for investors over the medium term. A China focused on massive capital expenditures to achieve self-reliance in key industries may not be a China that delivers high returns for public-stock investors.