The world’s second-largest economy has been losing steam for the past few quarters, resulting in an annual growth rate of 6.6% in 2018 – which is impressive by developed-market standards but a 28-year low for China.
Behind that slowdown has been the Chinese government’s crackdown on excess borrowing and its US trade tiff. Beijing has yet to strike a longstanding trade deal with Washington, with the clock ticking down to a March 1 deadline when the tariffs tit-for-tat could resume and negotiations on issues ranging from intellectual theft to Chinese market access still stalled.
That said, China has introduced stimulus measures to its economy to counteract the negative effects brought about by the slowdown and the US tariffs on its exports, including lower bank reserve requirements and tax cuts.
As a result, for investors looking to allocate funds to China, there are potential pockets of opportunities after Chinese A-share indices ended down roughly 25% in 2018. Chinese demand for electric vehicles in China, for example, is estimated to have soared by 62% last year and China’s Association of Automobile Manufacturers predicts a further 1.6 million in sales in 2019.
With the Chinese economy steering towards a more consumption-driven market, the question remains: how do investors take advantage of the remaining growth potential while managing the risks?
AsianInvestor asked four specialists for their views on the state of the Chinese economy and where the best investment opportunities might lie.
The following extracts have been edited for brevity and clarity.
Charles Sunnucks, emerging markets fund manager
Jupiter Asset Management
The combination of a [weaker] market ... and around 10% of projected earnings growth over the year have brought [share] valuation levels down to near multi-year lows. The outlook, however, is complex. Beyond the headline numbers, a serious change in China has shaken corporate prospects, creating a range of both evolving risks and substantial opportunities.
Uncertainty over trade tensions between the US and China has impacted both the exporters as well as corporate and consumer confidence in China. Already, out of China’s roughly $500 billion export value to the US, around $200 billion is now under a 25% tariff. In addition, there is the threat to impose a tariff on an extra $300 billion in March if a trade deal is not reached.
Policymakers have rolled out biting change within the financial sector in 2018; there has been tightened regulation around online activity and a continued reduction of excessive supply in key industries. These moves, against a background of uncertainty over the trading outlook for the country, has had a clear effect on domestic confidence, putting pockets of the economy under pressure.
We are going into 2019 with a less supportive macroeconomic backdrop, but we believe the increasingly divergent outlook within China’s corporate universe should gradually be reflected via a decoupling in valuations across the market. This will likely be most apparent in the small/mid-cap part of the market, where considerable underperformance has created several highly attractive bottom-up opportunities.
Jian Shi Cortesi, portfolio manager
GAM Investments
Chinese government policies have turned supportive. Monetary conditions have been loosened. The reserve requirement ratio for banks has been lowered to promote lending. The government has also announced a personal income tax cut to boost disposable income and discretionary spending. Other potential consumption [forms of] stimulus in auto and home appliance purchases could also be rolled out gradually.
These measures should help mitigate the negative impact [of] US tariffs and help prevent a dramatic slowdown in China’s economic growth ... In the long term, it would help the Chinese economy to continue the transition towards a consumption-driven economy.
Following a [stock market] correction of more than 30% from the January 2018 peak, I believe many negative factors are known and [are already] priced into Chinese stock prices. Valuations have come down to a very low level – at 11x [forward earnings] ...
2019 earnings growth is likely to be in the single digits for Chinese equities. Any progress with the US-China trade negotiations could change the sentiment from “very negative” to “less negative”, which in my view would be enough for the Chinese equity price-to-earnings ratio to rebound from the current low level. Putting these two factors together, I’m optimistic [about] Chinese equities in 2019.
I think the Chinese government will continue to tighten regulations related to pollution and other environmental issues, which would be negative for highly polluting heavy industries and positive for products that promote energy efficiency.
Rob Marshall-Lee, head of Asian and emerging equities
Newton Investment Management
Over the past 12 months, we have witnessed a huge amount of market fear over China. Despite its underperformance in 2018, the MSCI China index has significantly outperformed its Europe equivalent over the past three, five and 10 years. Indeed, it still trades at a substantially lower forward price-to-earnings consensus multiple than European equities, demonstrating that outperformance has been driven largely by profit growth.
The quality of growth is set to improve. A slower rate of GDP [growth] should be expected as growth rebalances, but it should not hinder the consumer-facing areas of the economy. Recent policy [has sought] to ease credit provision and drive the middle classes through income tax and VAT cuts.
Consumption-focused growth will spur on tertiary industries, which represent a growing share of GDP. Additionally, policy changes bode well for service sectors, such as education, healthcare, insurance and the internet, which is where our Chinese holdings are focused on [over] a multi-year view. Better corporate governance and sustained growth potential are all key considerations for long-term investors aiming to compound returns.
Investors are now faced with attractive entry points for many of the best Chinese companies, as concerns over trade wars and previously tight monetary policy have created opportunities in the market. Moreover, the devaluation of the Chinese currency against the dollar has offset much of the reduced competitiveness caused by any increased tariffs. We continue to see very strong growth from many consumer-centric Chinese companies, as well as [from] multinationals selling into China in sectors such as education, luxury and cosmetics.
Carl Tannenbaum, chief economist
Northern Trust
China has adopted fiscal and monetary policy measures such as fast-tracking infrastructure projects and cutting taxes and banks’ reserve requirements. China has also started approving local government bond issuances earlier than usual this year.
The government is likely to announce further fiscal stimulus measures during its annual parliamentary gathering in March. The measures may include further tax reductions and higher spending on infrastructure projects. These policy measures might help the economy avoid a hard-landing in the short-term … but the old measures that in the first place are the root cause of imbalances will only amplify structural problems in the long-term.
A key issue [for Asia-based investors trying to allocate to China] would be rising corporate bond defaults ... as China is allowing more corporate bonds to default (although it is a positive move in the long-term).
Bearing in mind the domestic and external concerns, investing in China will incur more risks in 2019 than last year. A trade deal [with the US] is still far from certain and there is a significant slowdown in the economy. Chinese companies are also facing increasing market-access challenges, especially in the US. China seems to be going back on its reforms agenda by using debt as a tool to underpin the economy.
Housing policies will remain quite tight as policymakers will not broaden the financing channel for developers to boost the property market. There will be a continued focus on curbing shadow banking activities. Attention to the environment will remain a priority, with [a] particular focus on electric vehicles and alternatives to coal.
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