Goldman Sachs Private Wealth Management sounded a downbeat note on China’s growth prospects yesterday, while making the case for US equities on the back of strong fundamentals and cheap valuations.
Worries are looming over China’s financial sector; banks account for over 40% of domestic stocks’ market capitalisation, and their valuations are 25% below their average price since January 2003.
“They are cheap, but they are cheap for a reason,” says Neeti Bhalla, global head of tactical asset allocation in Goldman’s wealth division. “People don’t know what the banks hold, what the non-performing loans could look like and what the profitability of these banks will be like should there be interest rate liberalisation.”
The risk is particularly magnified for banks listed on the A-share market, which tend to be more regional and smaller than those listed in Hong Kong, suggesting that their exposure to bad debts generated by local governments could be greater.
Chief investment strategist Ha Jiming emphasises the long-term need for the government to push through much-needed reforms to reduce the economy’s dependence on infrastructure spending and find a new catalyst to boost the economy.
A key reform to encourage growth would be to reduce the monopoly enjoyed by state-owned enterprises, spurring greater competition and potentially introducing more efficiency among SOEs and the wider economy.
Practically, this may mean giving the private sector more access to capital, but also opening protected industries such as infrastructure to the private sector.
Reforms are also needed on the social policy front, such as with regard to the household registration system known as hukou, which separates urbanites from the rural population.
While 50% of China’s population now lives in urban centres, the real rate of urbanisation is only 35% if the hukou system is factored in, as those who do not enjoy urban residency status are reluctant to spend due to the lack of a welfare safety net.
Rural people need to be ‘urbanised’, so those who live in dormitories in their hundreds can have their own place to live, says Ha. “If that is to happen, imagine what it is going to do? Instead of hundreds of workers watching one TV set provided by their employers, 100 workers will buy 100 TV sets, or 100 refrigerators if they have their own place to live. That will make a huge difference.”
With the lack of a clear catalyst driving Chinese markets, Goldman suggests the market will trade range-bound. Given the level of volatility and the lack of visible risk-taking, says Bhalla, “the risk seems high”.
This view stands in contrast to the bank’s bullishness on US equities. The S&P 500 has rallied by more than 10% year-to-date, as against a drop of -3% for China’s CSI 300 index.
“The first theme we think should drive [US] asset returns is that in fact today the assets are better valued than they have been at any point other than at the depth of the financial crisis over the last 10 years,” says Bhalla.
The S&P 500 traded at a forward price-to-earnings ratio of 13.8 times in mid-April, compared to 15 times in 2007 before the global financial crisis and 25.1 times in the dot-com bubble of year 2000.
Supporting this valuation are stronger macroeconomic fundamentals for the US economy. Goldman suggests manufacturers are likely to continue bringing operations back onshore on the back of a weaker dollar compared to currencies such as the renminbi, falling wage costs and low union membership, as well as greater energy independence thanks to the oil shale boom.