Equity prices only tell half the story; for the bigger picture you need to look at earnings expectations. For the latter, the onshore/offshore valuation gap widened sharply between October 2019 and February 2020, when A-shares underperformed despite seeing better upward earnings revisions during that same period.
Fast forward to today, when around one-third of Chinese companies have reported first-half results. So far, average earnings rose 9 per cent for A-shares versus falling 2 per cent for Hong Kong-listed mainland companies. That’s why onshore stocks still look cheaper on a forward price-to-earnings basis, as future PE estimates get revised upwards more sharply for A-share companies.
This dichotomy is increasing investment from overseas investors and encouraging stronger northbound flows from Hong Kong to the mainland via Stock Connect, providing another tailwind to A-shares.
There’s certainly no absence of enthusiasm among onshore investors. When comparing apples to apples, dual-listed stocks have A-shares trading at a 35 per cent average premium to their H-shares, near the high end of the 3-year historical range. But regardless of these differences, we see both indices trading at reasonable PE ratios in the low-to-mid-teens.
Returns have stalled amid combative rhetoric
Chinese stocks have stalled since mid-July, when tensions escalated between the US and China. While rhetoric may remain combative in the run-up to the US presidential election in November, support for the US government’s apparent China containment strategy looks to be bipartisan. Over the past month, returns from both onshore and offshore Chinese equities have been generally flat while many stock markets elsewhere in the world continued their rallies.
That said, the China market reaction has been more muted than the double-digit losses that occurred during the initial volleys of the trade war in 2018. Back then, Chinese authorities were tightening monetary policy to restrict excessive credit growth that had been a boost to stocks.
Today, a much more accommodative policy is supporting the economy and domestic markets. Onshore margin financing for stock purchases is only around half of the excessive levels seen in 2015, suggesting fundamentals have been a bigger driver than speculation in the rally we’ve seen since March.
Despite the present pause in the rally, the encouraging indications so far from earnings season suggest there are good reasons to think the resilience in Chinese stocks can last.