Goldman Affirms Bullish China Stocks Call in Face of Taiwan Rift

  • Sees 24% potential returns in Chinese shares in next 12 months
  • Volatility may rise as US-China tensions to remain elevated

Strategists at Goldman Sachs Group Inc. are staying with their bullish call on Chinese equities even as they warn that geopolitical risks may fuel more volatility in the near term.

The outlook for China’s stocks is supported by prospects of an economic recovery in the third quarter, contained inflation and easing policy in the region and globally, strategists including Kinger Lau wrote in a note Thursday. The risk-reward profile is turning favorable again, barring a further worsening in geopolitical tensions, they added.

“Hence, we stay overweight Chinese equities and forecast 24% potential returns over the next 12 months,” the strategists wrote. “But the path to get to our 12-month index target could remain bumpy until key political events in the US and China conclude and more clarity on ADR delisting and local regulations emerges.”

A recent rebound in Chinese shares has faded as tech crackdowns, the threat of a delisting of firms in the US and a deepening property sector crisis deter investors. Previous calls for a bottom in the stocks have proved premature, highlighting the challenge investors face in navigating the market.

US House Speaker Nancy Pelosi’s visit to Taiwan this week has been another flashpoint for Chinese shares, as Beijing retaliates with military drills and trade curbs against the island. China’s stocks rebounded Thursday from a drop triggered by the tensions but some analysts warn that the repercussions may linger long after the trip is over.

Morgan Stanley has also cautioned that volatility may surge over the coming week or two. Investors have been adding new hedges and as a result, one-month implied volatility on CSI 300 index options has soared to 24.4%, compared with 13.5% for one-month realized volatility.

The gap is the widest in two years and suggests domestic investors are “very much willing to pay a high premium to protect against market downside risk,” Morgan Stanley analysts led by Gilbert Wong, wrote on Wednesday.

Caution Ahead

Meanwhile, the Goldman strategists noted that valuations on Chinese equities are negatively correlated with geopolitical risks. This is illustrated in the firm’s US-China Relations Barometer and Cross-Strait Barometer, where every one standard deviation move, which reflects increasing tensions, may translate into a 3.2% cut in the price-to-earnings ratios.

Near-term caution is probably warranted, given that US-China tensions are likely to remain elevated, global recession risks persist and 2022 consensus earnings risks are skewed to the downside, especially in the housing sector, the Goldman strategists wrote.

Author: Tassia Sipahutar, Bloomberg

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