China is doubling down on advanced manufacturing in an effort to boost its economic resilience both in the short and long term.

China’s push for high-end manufacturing is not new. The field has been high on China’s development agenda for some time as the country seeks to advance home-grown innovation, especially in core technologies such as new energy vehicles (NEVs), precision components, integrated circuits and high-end equipment.

Slower-than-expected growth

However, it has become even more urgent given concerns that China’s economic recovery is stalling. According to latest data released by China’s National Bureau of Statistics, manufacturing activity declined for a third month in June while service sector activity slowed to its weakest level this year. As a result, China’s GDP forecasts have been softening. Many economists now expect China to record GDP growth of between 5.1 percent and 5.7 percent in 2023, down from earlier forecasts of 5.5 percent to 6.3 percent.

Technology investments being stepped up

In the coming months, we expect to see more targeted policies for China’s advanced manufacturing industries as authorities seek to prop up the economy. For example, China plans to restructure its science and technology ministry to channel more resources into accelerating technological self-reliance.

The government also plans to nurture more than 80,000 tech small and medium enterprises (SMEs) with funding and business incubation platforms by the end of the year, as part of ongoing efforts to develop self-sufficiency in critical technologies.

Currently, approximately 60,000 SMEs have been identified for support. Such SMEs typically specialise in niche sectors and possess capabilities in strategic areas like advanced manufacturing. In 2022, these SMEs accounted for 59 percent of IPOs in the China A-share market¹.

ChiNext index expected to benefit

This bodes well for the long-term prospects of the ChiNext index. Of China’s three core technology indices, the ChiNext is most inclined towards advanced manufacturing.

Figure 1: Overview of China’s tech indices

While the ChiNext index has come under pressure in recent months due to China’s sluggish economic recovery, we see potential turning points in the market – and note its outperformance over the broad-based CSI 300 index since 2020.

Figure 2: Total returns: ChiNext vs CSI 300 index, 2018 - 2023

Source: Bloomberg, 7 July 2023

Here are four catalysts for a potential short-term upturn in the ChiNext index:

1. Possibility of more policy support

China’s faltering economy raises the chances of an imminent stimulus package to boost growth, although Premier Li Qiang has emphasised that policies would be “targeted, comprehensive and well-coordinated”.

As such, it is likely that support will be targeted at sectors considered important for China’s economic growth. For instance, the government recently introduced a 520 billion yuan (S$97 billion) package of tax breaks for NEVs – the largest yet for the industry.

2. Strong earnings growth

Despite the muted outlook for China’s economic recovery, many companies within the ChiNext Index are set to see relatively robust earnings growth given their stable fundamentals and contributions to China’s economic transformation and upgrading.

Year-on-year, the ChiNext index has recorded an average earnings per share (EPS) growth rate of 21 percent since 2015, outpacing the 5.2 percent EPS growth rate of the broad-based CSI 300 index².

Furthermore, we expect to see strong year-on-year profit growth of 36.4 percent and 30.9 percent for ChiNext Index constituents in 2023 and 2024 respectively³.

Figure 3: Net profits for ChiNext constituents

Source: Ping An Fund Management Company, June 2023

3. Market rotation back to tech

Since 2010, Chinese stock market leadership has seen continuous rotation across different sectors. For instance, advanced manufacturing and healthcare recorded relatively strong performance in 2020 and 2021. In 2022, it was the finance and real estate sectors’ turn to shine. So far this year, the technology, media, and telecom (TMT) sector has been outperforming.

However, with TMT sector valuations looking relatively expensive at the moment, there is an increasing likelihood of TMT profit taking, and a market rotation to other sectors.

Technology and advanced tech-based engineering look like good candidates, fuelled by investor enthusiasm for artificial intelligence (AI)-driven companies.

Figure 4: China’s stock market rotation, 2010 – 2023 YTD

Source: Wind, as of June 2023

4. Compelling valuations

At 31.4 times, the price-earning (P/E) ratio of the ChiNext index is near lows last seen in late 2018. This implies a relatively good margin of safety – defined as the difference between the intrinsic value of a stock and its current price – and hence, relatively less risk in the investment at this stage.

Moreover, given that valuations have been depressed for some time, it is likely that potential negative news have already been largely priced in.

Figure 5: ChiNext index P/E ratio

Source: Ping An Fund Management Company, June 2023

ChiNext positioned for long-term growth

Apart from the turning point opportunities in the nearer term, the ChiNext index could see longer term benefits from China’s efforts to strengthen its high-end manufacturing industry.

During the June 2023 rebalancing, the index added several companies involved in the production of semiconductor equipment and parts, such as Jiangfeng Electronics. As a result, high-tech enterprises currently account for 94 percent of the index total weight, while the three key areas of advanced manufacturing, digital economy, and new energy (including NEVs and renewable energy) account for 83 percent of the total weight⁴ .

Figure 6: New additions to the ChiNext index

Source: CNI Index and Wind, as of June 2023

For many investors, geopolitical tensions including the US-China chip war (See Research Note | China’s AI focus continues despite US-China chip war) and weak economic data remain key concerns. If these headwinds intensify, Chinese shares could see further declines in the short term.

However, we believe the longer-term outlook for the ChiNext index remains intact given strong fundamentals. Should more stimulus measures be rolled out, sentiment could brighten and support a price rebound.

¹China Ministry of Industry and Information Technology, February 2023

²Ping An Fund Management Company, June 2023

³Ping An Fund Management Company, June 2023

⁴Source: CNI Index and Wind, as of June 2023