Morgan Stanley Strategist Who Called China Rout Still Won’t Buy

Jonathan Garner is a notable holdout in a market where an increasing number of strategists have turned bullish on Chinese stocks.

Having warned about valuation and macro risks in Chinese equity markets just before they crashed in February last year, the chief Asia and emerging markets strategist for Morgan Stanley thinks it’s too early to call a bottom. His caution stands in contrast to Goldman Sachs Group Inc. and others, whose strategists expect double-digit gains in Chinese stocks this year.

“How much longer, or further, can this bear market go?” Garner said in a Jan. 11 interview with Bloomberg News, citing threats from the omicron variant as well as rising U.S. interest rates. “Our judgment is we’re getting closer to the end, but unfortunately, we think that further de-rating of the growth part of China and emerging markets is likely.”

His year-end targets for Hong Kong’s Hang Seng Index and the mainland’s CSI 300 Index are at 25,000 and 5,250 respectively, suggesting little upside for the former and nearly 10% gain for the latter as of close of trade Friday.

Chinese stocks started 2022 on a positive note following last year’s tumble, as investors bet the worst of Beijing’s regulatory crackdowns were over and hoped monetary policy easing would add tailwinds.

The Hang Seng China Enterprises Index has advanced more than 6% so far in 2022, outperforming the S&P 500 Index which had lost almost as much as of Friday in Hong Kong. That divergence was partly driven by the People’s Bank of China’s pledge to take more action to prop up the economy, while the Federal Reserve has made it clear that interest rate hikes will start in earnest from March.

However, to Garner, the falling return on equity for Chinese companies and property defaults are still of concern. The ROE for the MSCI China Index peaked during the 2007-2008 cycle at 18% and is currently at 12%, according to Morgan Stanley.

Here are highlights from the interview with strategist and author Garner, 56, as he discusses market views and his experiences covering the market.

Q: What are the key indicators you are watching to decide on the turning point for the market?

It comes down to earnings, valuations and technicals, but ultimately we’ll probably need more policy stimulus from China. We’re also watching for the property sector’s developments, and this global de-rating of growth stocks and how that unfolds.

Q: Have you faced clients’ skepticism about your calls given that valuations have come down a lot?

Yes, there’s been lots of active debate. It’s true that both absolute and relative valuations have become far more reasonable than a year ago, but we are also watching the kind of issues like – What are you paying for here? What’s the trend in corporate return on equity? In China, unfortunately, corporate return on equity is falling in both absolute and relative terms.

Q: What made you turn bearish on Chinese stocks in January last year?

Our earnings model was showing significant risks to the bottom-up consensus, both in China and emerging markets. China was trading at almost two standard deviations compared to the medium-term history.

We knew a lot of money had come into the market very quickly, but it had driven valuations to an excess. And it was premised on macro and earnings outlooks that we didn’t believe in. We argued in November that we were still not yet at the bottom of the earnings cycle.

Q: What’s your boldest call about markets right now?

I think it would be that long-term call about the “financialization” of savings. As Asian investors transit out of portfolios that are bank and property-centric to owning securities, there’s a multi-trillion dollar investment theme, which is only just beginning. And it’s not just a China story. Asian investors will drive Asian markets, and own mutual funds, private equity and hedge funds.

Q: How has the China story changed since you’ve been covering this market?

China has moved from being marginal in global investor debates to being central. When I was writing research notes and then the book, “The rise of the Chinese Consumer”, in 2005, many investors were very skeptical. They couldn’t conceive that Chinese consumers would become as important, if not even more important, for sectors and firms as those in the advanced economies.

Q: Do you consider yourself a lifer in Hong Kong?

I think the future is extremely bright for the area that I work in – which is the financialization of savings here in Asia – and Hong Kong is a great place to do it. In this industry, including here in Hong Kong, we have a genuine commitment to diversity and inclusion.

At Morgan Stanley, we’ve seen a growing trend of female representation at the firm level. Our representation of women in senior roles has increased by a third since I started working at Morgan Stanley.

Q: When were the most vulnerable moments in your career?

I was probably the most vulnerable early on in the Asian and Russian crisis in 1997-98, when I was just getting going. And again, during the global financial crisis, I made a very visibly wrong call that Asian markets could decouple from the subprime problem in the U.S.

Asian markets ultimately came back very strongly in line with my view. Right at the end of 2008 when the famous 4 trillion yuan stimulus package was announced, I was actually in Beijing. I remember being very excited, seeing that and realizing what that could do for the market in 2009.

Author: Jeanny Yu, Bloomberg

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