Goldman Sachs has adopted a more optimistic stance on Chinese equities, increasing price targets on domestic indexes and launching a 40-stock China Recovery Portfolio.
Kinger Lau, CFA, and his team at Goldman Sachs see a “tail-risk compression trade” in progress, following a substantial rally in Chinese stocks.
The MSCI China Index, as tracked by the iShares MSCI China ETF MCHI, has risen 31% from its lows in late January and 19% in the past month, outperforming most developed and emerging market equity indices.
According to Goldman Sachs’ historical analysis, there’s a 60% probability that Chinese stocks will continue to rise after entering a technical bull market, with potential maximum returns averaging 35% over the next six months.
Chart: Chinese Stocks Sharply Rebounded Recently
China At An Inflection Point?
Recent weeks have seen a reduction in property-related risks, and Goldman Sachs noted that China’s macroeconomic performance has exceeded expectations. The first quarter real GDP growth was 5.3%.
On the policy front, the Chinese government has introduced several measures to stimulate the property sector, including lowering the minimum down payment ratios by 5 percentage points to 15% for first homes and 25% for second homes, which are the lowest levels on record.
Additionally, the government has removed the minimum mortgage rate floors and has also set up a RMB 300 billion (USD 41 billion) relending facility, which, combined with commercial bank lending, could reach RMB 500 billion. This initiative aims to support local governments in purchasing unsold housing stock for conversion into social housing.
Market Dynamics and Investor Sentiment
Recently, a ‘FOMO’ (fear of missing out) effect has driven the market.
“The combination of decade-low allocations to China from both hedge- and long-only mandates and the rapid pace of recovery has caught investors off guard.”
This has created performance pressures, prompting investors to close underweight positions or increase their exposure to Chinese stocks, thereby fueling the market’s upward trend.
However, discussions with global investors reveal concerns about potential disappointments in domestic policies, particularly those related to housing, and the risk of escalating U.S.-China tensions as the U.S. election approaches.
Goldman Sachs analysts pointed out that Chinese equities have become less reactive to bilateral tensions compared to a few years ago. This decreased sensitivity is due to a better understanding and pricing of these risks, which helps explain the strong market momentum despite new tariffs imposed by the Biden administration last week.
“Our Bull, Base, and Bear cases project 25%, 8%, and -13% potential upside respectively for MSCI China in the next 12 months,” indicating a favorable risk/reward ratio even if U.S.-China relations were to worsen.
Goldman Sachs has developed a diversified portfolio consisting of 40 Chinese stocks across various sectors and themes. Prominent stocks in this portfolio include Tencent Holding Ltd. TCEHY, Alibaba Group Holdings Ltd. BABA, Meituan MPNGY, BYD Co. Ltd BYDDY, Li Auto Inc. LI, and Trip.com TCOM.
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Image generated using artificial intelligence via Midjourney.
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