Chief China Strategist
Summary: Hong Kong stocks surged last Friday on reports of a potential dividend tax cut for mainland investors. This could encourage greater participation in the Hong Kong market. China's exports rebounded in April, driven by shipments to ASEAN economies and motor vehicles. CPI inflation ticked up due to holiday travel spending, while credit growth slowed sharply. The domestic automotive market remained sluggish, with a decline in passenger vehicle sales. Additionally, the US is considering increasing tariffs on Chinese clean-energy products, including EVs. Also in focus for investors this week are the earnings reports from Alibaba, Tencent, Meituan, JD.Com, and Baidu. A viable strategy could be a barbell approach: staying long on high-dividend Chinese SOE names listed in Hong Kong, and hard-technology names in the A-share market.
Hong Kong stocks rallied on Friday, with the Hang Seng Index surging 2.3% and the Hang Seng China Enterprises Index climbing 2.4%, driven by reports that Chinese authorities are considering reducing the dividend tax for mainland investors in Hong Kong stocks. High-dividend stocks, particularly Chinese banks, telecoms, and energy companies, led the gains. Additionally, the Hong Kong Exchange and Chinese securities firms also gained significantly on Friday, anticipating a higher volume of mainland investors buying Hong Kong stocks via the Stock Connect..
Currently, mainland investors face a flat 20% tax rate on dividends earned from Hong Kong stocks through the Stock Connect program, regardless of the holding period. In contrast, for domestic A-shares, the tax rate is 20% for stocks held up to one month, 10% for holdings between one and twelve months, and zero for stocks held over a year. Aligning the dividend tax rates for Hong Kong and domestic investments could create a more consistent taxation framework for mainland investors. Such a move could potentially encourage greater participation from mainland investors in the Hong Kong stock market, fostering the valuation of stocks traded in Hong Kong, particularly Chinese banks, telecoms, and energy companies, which pay high dividends and are beneficiaries of support from the ‘national team’, which consists of state-controlled investment entities.
According to estimates, dividend payments from Stock Connect-eligible companies amounted to HKD 1.8 trillion on average over the past three years, and the projected tax reduction impact could be around HKD 20 billion per annum. While the reported tax cut, if implemented, is a positive move, considering the average daily turnover of southbound flows has been around HKD 36 billion and the market capitalization of Stock Connect-eligible stocks is nearly HKD 30 trillion, the HKD 20 billion annual tax cut is not a game-changer for the Hong Kong stock market.
China's exports rebounded in April 2024, growing 1.5% year-on-year in USD terms, a significant improvement from the 7.5% decline in March. This outperformance exceeded Bloomberg's survey of economists, which projected a 1.3% growth rate. The surge was primarily driven by a 13.0% Y/Y increase in exports to ASEAN economies, contributing 2.1 percentage points to the overall 1.5% export growth.
At the industry level, shipments of motor vehicles and ships were the major contributors to export growth. Motor vehicle and chassis exports grew 28.8% Y/Y, while ship exports skyrocketed 91.3% Y/Y in April. These two industries contributed 1.1 and 1.3 percentage points, respectively, to the overall export growth.
The export rebound reflects an ongoing reconfiguration of global supply chains, with China increasingly selling more intermediate goods to ASEAN countries and India, while these Asian economies export more finished products to the US and other Western markets. Vietnam and India have seen the share of intermediate goods in their imports from China rise to 70% and 37%, respectively. China is having trade surpluses with India, Vietnam, Thailand, the Philippines, and even South Korea in 2023. Among Asian economies, Taiwan is a notable outlier, which runs a large surplus with mainland China due to the former's formidable dominance in high-end microchip production. The rebound in China's exports in April 2024 has likely played a role in fueling the recent recovery in Chinese stock markets by improving the economic outlook and investor sentiment.
China's CPI inflation picked up to 0.3% Y/Y in April, from 0.1% in March. Excluding food and energy, the core CPI advanced by 0.7% Y/Y, bouncing modestly from 0.6% in March. The higher-than-expected CPI prints were driven by increases in service prices, particularly tourism-related spending on services during the Qingming holiday and making bookings in the approach of the Labor Day holiday. Air ticket prices jumped 15.3% while rental vehicle and hotel prices increased by 4.0% and 2.7% month-on-month, respectively.
On the other hand, headline PPI came in at -2.5% Y/Y in April, slightly less deflationary than the -2.8% in March. However, the downward pressure on PPI on a month-on-month basis intensified, as reflected in the -0.2% print in April, versus -0.1% in March.
China's new aggregate financing came in at negative RMB 198.7 billion in April, signalling credit contraction during the month and far below the consensus estimate of an addition of RMB 940 billion. The contraction dragged the year-on-year growth of the total outstanding aggregate financing down to a new low of 8.3% from the previous month's 8.7% and the end of 2023's 9.5%. A smaller addition of new corporate loans of RMB 860 billion, a net repayment in long-term household loans (primarily mortgage loans) of RMB 167 billion during the month, and a net repayment of RMB 98 billion in government bonds contributed to the negative print in aggregate financing in April.
The loan data, however, may need to be taken with a grain of salt because the National Bureau of Statistics has changed its method of compiling the value-added from the financial industry, from referencing the growth rate of outstanding loan balances to focusing on banks' profitability measures. This might have reduced the incentives for local governments to intervene to boost the loan balance numbers at financial institutions in their localities.
The growth in money supply also sharply decelerated, with M2, the broad measure of money supply, increasing at a much slower-than-expected rate of 7.2% versus 8.3% in March and 9.7% in 2023. For the narrow measure of money supply, M1 contracted by 1.4% in April. The People's Bank of China withdrew liquidity from the system through maturing Medium-term Lending Facility (MLF) loans and Pledged Supplementary Lending (PSL) during the month.
Two significant data series were released regarding the performance of China's automotive industry in April. The reports, issued respectively by the China Passenger Car Association (CPCA) on May 10 and the China Association of Automobile Manufacturers (CAAM) on May 11, painted a picture of a weakening domestic market for autos in China.
Starting with the CAAM report, which provided production and wholesale data from auto manufacturers, it revealed a 10.5% M/M decline or 12.5% Y/Y growth to 2.41 million vehicles in production. Sales also saw a 12.5% M/M decline or 9.3% Y/Y growth to 2.36 million vehicles in April. Specifically, the production of passenger vehicles dropped by 9.0% M/M or increased by 15.2% to 2.05 million vehicles. Meanwhile, sales of passenger vehicles fell by 10.5% M/M or rose by 10.5% Y/Y. The year-on-year growth in production and wholesale in April was primarily fueled by a pickup in exports of passenger vehicles to 429,000 units. However, domestic consumption was slow to recover, with domestic sales of passenger vehicles declining by 13.2% M/M or growing by a modest 5.1% Y/Y to 1.57 million units in April. Domestic sales of commercial vehicles also dropped by 25.6% M/M or 1.6% Y/Y to 283,000 units in April.
Likewise, according to data from the CPCA, which focuses on retail sales data, China’s passenger vehicle retail sales fell by 9.4% M/M or 5.7% Y/Y to 1.53 million units. Both sets of data indicated sluggish domestic consumption of passenger vehicles in April, potentially offsetting some of the strength observed in tourism-related consumption during the month.
Investors are now eagerly awaiting the release of retail sales data scheduled for this Friday to confirm the trend of domestic consumption. According to a survey by Bloomberg, the median forecast is projecting a pickup to 3.7% Y/Y growth in China’s retail sales in April from 3.1%.
According to the Wall Street Journal, the Biden administration is poised to announce a decision to increase tariffs on Chinese clean-energy products this Tuesday. The tariff on electric vehicles (EVs) from China may rise from the current 25% to as high as 100%. While China currently isn't exporting significant quantities of EVs to the U.S., Chinese EV manufacturers like BYD are exporting to Mexico. They also plan to establish production capacity in Mexico to leverage exporting to the U.S. under NAFTA. The potential impact of the reported Biden tariffs on the Chinese EV industry hinges on specific rules concerning EVs manufactured in Mexico or other countries by Chinese EV manufacturers. We will soon release a separate report on Chinese EV stocks.
Also, aside from the macroeconomic discussion, investors will focus on the earnings reports from Alibaba and Tencent on Tuesday; Meituan, JD.COM, and Baidu on Thursday.
For investors with a cautious outlook on the Chinese economy and equity market, a viable strategy could be a barbell approach: staying long on relatively defensive high-dividend Chinese state-owned enterprise (SOE) names listed in Hong Kong, and hard-technology names in the A-share market. This positioning accounts for the potential dividend tax cut that could boost high-dividend SOE stocks and continuous support to the SOC sector by state-controlled investment entities, while also capitalizing on China’s industrial policies in support of the hard technology sector.
Investors with a more constructive view on a cyclical recovery in Chinese consumption may consider a slightly long position in China e-commerce names. However, Chinese EV stocks face challenges such as sluggish domestic sales, margin pressures, and potentially deteriorating export markets, particularly in Europe where Chinese automakers had high hopes but are facing increasing barriers to entry.
For the medium term, the risk to the Chinese equity market remains high and a substantial pullback on the potential disappointment on the outcome of the Third Plenum this July and a structurally slower growth rate of the economy, plus the risk of deterioration in the geoeconomic environment for China.
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Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
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