China’s stock market had a terrible 2018. This year could be a lot better

China’s beaten down stock market could be headed for a rebound.

The benchmark Shanghai Composite was the world’s worst performing major stock market last year, tumbling more than 25%. It was weighed down by fears about China’s slowing economy and the trade war with the United States.

But 2019 could be much better. Analysts at HSBC (HBCYF) forecast Chinese stocks could rise a further 18% this year after already gaining 5% in January. A resurgent stock market could help improve the gloomy mood among Chinese consumers, whose reluctance to spend has hurt top global brands like Apple (AAPL).

Much depends on the United States: A deal to ease trade tensions would boost Chinese share prices, and so could a lull in rate hikes by the Federal Reserve.

Apple roiled global markets after it unveiled it expected a weaker Chinese economy to hurt its holiday sales numbers.

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Chinese stocks would hold strong appeal “in a world where they agree a trade deal,” said Christopher Wood, an equity strategist at Hong Kong-based broker CLSA.

He predicts the two governments will reach some kind of agreement by early March to prevent a return to their bruising trade war.

“If China is smart, they will do a deal with Donald Trump,” Wood said, describing him as “the most friendly president Beijing is going to deal with, given anti-China sentiment is growing in Washington.”

The potential removal of tariffs on $200 billion worth of Chinese exports as part of a deal would be especially positive for the Shanghai market, he said.

Fed takes the pressure off

The US Federal Reserve’s signals this week that it will throttle back its plans to raise rates this year could be good news for China.

WASHINGTON, DC - DECEMBER 06: Federal Reserve Board Chairman Jerome Powell speaks during a Rural Housing Assistance Council Awards Reception, on December 6, 2018 in Washington, DC. (Photo by Mark Wilson/Getty Images)

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Rising US interest rates in 2018 pulled more money into American assets, pushing up the value of the dollar and making investments in the Chinese yuan less attractive. But after the Fed comments this week, the yuan hit a six-month high against the dollar.

“When the dollar is weak, emerging markets and China tend to do well,” said Mark Tinker, head of Asian equities at investment firm AXA Framlington.

A more dovish Fed also gives greater Beijing breathing room to juice the Chinese economy with looser monetary policy, which tends to drive money into stocks.

‘Crisis-level valuations’

Fund managers say another reason to buy Chinese shares is they look so darned cheap.

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Last year’s sell-off has left stocks listed on the Shanghai Composite trading at a discount of about 40% compared with those on the S&P 500, according to Refinitiv data.

Chinese stocks “are at crisis-level valuations for an economy that is still growing faster than most places around the world,” said Eric Moffett, a portfolio manager at investment firm T Rowe Price.

Investors should focus on stocks in sectors that have been hit hardest by trade tensions and China’s economic downturn, such as autos and big exporters, according to Moffett.

“The bad news has largely been priced in,” he said.

‘A very bad earnings season’

A rebound in Chinese stocks is far from guaranteed, though.

China’s economic situation is likely to get worse before it gets better. A lot of economists forecast that growth will reach its weakest level in the second quarter.

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The latest signs are not encouraging. A closely watched indicator measuring the health of China’s huge manufacturing sector sank to its lowest level in nearly three years last month.

Chinese companies are feeling the pain. State media reported this week that more than 300 listed firms are warning of losses of $15 million or more for 2018.

Chinese stocks “are hampered by a very bad earnings season,” said Hao Hong, head of research at Hong Kong broker BOCOM International.

That leaves investors anxiously waiting to see how the trade talks with the United States pan out.

“If you don’t believe there’s going to be a trade deal, you should probably sell equities today,” Wood said.