Outlook 2017: Greater China equities
Despite policy uncertainty, the region still offers promising long-term opportunities.
22 December 2016
President-elect Donald Trump’s surprise victory in the US presidential election in early November has seen uncertainty reign in global markets and it is expected to bring about pronounced uncertainty and volatility in different asset markets and currencies in the short term.
The overriding question after Trump’s victory is the duration and sustainability of reflation trades1 – the rotation from new to old economy sectors, from bond proxies2 to interest rate sensitives, from emerging to developed markets.
The Trump presidency has raised hopes of stronger economic growth in the US, given his promise of fiscal spending, job creation and tax cuts. The US 10-year bond yield has already risen from 1.85% before the US election to 2.4% of late. Recent commodity prices have also attracted bids while oil prices have been supported by the latest OPEC production cuts.
It is still too early to make a sensible judgment on Trump’s policies as there are little details known at this stage. However, what has been articulated thus far is already fraught with potential risks, including concerns over the burden of the fiscal deficit in the US and the negative impact on the mortgage and consumer debt servicing capability of consumers.
The stronger US dollar will also act as a drag on US corporate earnings – the whole reflationary theme could potentially be “short circuited”. However, for now, expectations are high while momentum in markets remains powerful and there are enough reasons to believe investors will continue the ‘reflation trades’ in the near term.
What will Trump mean for Greater China equities?
Some of the old economy sectors, be it materials, energy or capital goods, will be likely beneficiaries of expectations of better growth prospects and increased infrastructure spend in both China and the US.
In general, Trump’s victory will bring further uncertainty and volatility in markets. The following are some areas that are of particular relevance to Hong Kong/China markets:
- Higher interest rates/steepening of yield curve – with a steepening yield curve and moderate pick-up in inflation, we are expecting interest rates in China to gradually bottom out in the near term, although we do not expect a spike thereafter. There is also the possibility that domestic liquidity will move from bond and property markets into domestic China equities and Hong Kong equities via the Southbound flow during the first half of 2017.
- Trade policies will likely turn more protectionist. Although Trump has labelled China as a currency manipulator, it is highly unlikely that he will implement draconian policies that will significantly deteriorate the Sino-US trade relationship. However, the Trans Pacific Partnership trade deal is likely to be suspended and select products could face higher import tariffs. This would generally be negative for global trade growth and select exporters with large US exposure would face more uncertainties.
- Continued infrastructure spending by China and other regional markets could provide some short-term support to commodity prices. However, the magnitude of price recovery might be limited given the overall overcapacity situation facing the industry.
- Historically, a strong US dollar is negative for emerging markets. This raises the risk of a potential withdrawal of liquidity from emerging markets, especially for smaller open economies. Of more relevance to China, this could put more pressure on the yuan exchange rate and capital outflows. The yuan depreciated 1.5% in October, and has continued the downward trend since Trump’s victory. In order to allow the exchange rate to adjust in an orderly manner amid massive outflows, China is likely to further implement capital controls through administrative moves. We are expecting the currency to further depreciate to 7.2-7.5 yuan per US dollar by the end of 2017.
Meanwhile, China’s economy has shown signs of stabilisation in 2016 on the back of accommodative monetary policy and more proactive fiscal policies. A slew of economic data, such as GDP, consumer price inflation (CPI) and producer price index (PPI), have pointed to a more stable outlook for the world’s second-largest economy.
In particular, the end of PPI deflation means better pricing power for upstream corporates, which could lead to improved profit margins from a low base.
Reform and property tightening
The ease in deflationary forces was largely due to a rebound in commodity prices on the back of a disciplined approach to ‘supply-side reforms’. The government’s aim to reduce overcapacity in industries, such as steel and coal, saw measures being put in place (including mine closures) that brought about a short-term price rebound.
However, only until we see more aggressive capacity reduction and a real improvement in demand will we be convinced that genuine reform has taken root.
Meanwhile, supportive policy has led to significant improvement in the property markets in tier-1 and tier-2 cities. Although the risk is to the downside here given the government’s latest property tightening measures, it is expected that state-led infrastructure investments will remain the key driver to support the economy next year in light of slowing property construction.
What will drive China markets?
Looking ahead, additional liquidity from the Southbound flows of the Stock Connect scheme (the programme through which investors in mainland China and Hong Kong can trade shares listed on the other market) and recovering earnings prospects in cyclical sectors (such as energy, commodities and capital goods) are positive factors that could drive markets higher.
On the negative side, the tightening of China’s property market, yuan depreciation amid capital outflows, higher interest rates, along with external political uncertainties, could potentially pose headwinds to the market.
Past performance is not a guide to future performance and may not be repeated.
The broader weakness in the Chinese economy, tighter capital controls and the continued drop in mainland Chinese tourists is still having a knock-on impact on Hong Kong economic growth.
Nevertheless, from a valuation perspective, domestic names in the bank and commercial property sectors, as well as diversified regional and global conglomerates look attractive today, on a longer-term view. Balance sheets for Hong Kong blue chips are typically very conservative, franchises robust, and management teams are well known to investors over many years.
On the other hand, we are cautious on Hong Kong residential property. Given the weak affordability locally, the government has continued to stamp out speculative demand in the residential property market through heightened stamp duties.
This, combined with increasing supply in the coming years, is likely to exert further pressure on the property market in 2017. However, the outlook for commercial properties is more resilient, with rents still rising modestly for Grade-A office buildings.
Taiwan’s economy remains anaemic, with overall credit growth subdued in recent years. The iPhone 7 is likely to be a transitional product while street expectations of the iPhone 8 are high.
In addition, competition from local Chinese electronic component suppliers have significantly intensified over the past few years, leading to lower margins for many Taiwanese players in the medium term. We are struggling to see a visible catalyst, led by Apple’s product cycle, to drive the re-rating of Taiwan’s technology sector.
1. Trading or investments that are aimed at benefitting from the trend of fiscal or monetary policies designed to expand a country's output and curb the effects of deflation.↩
2. Sectors and stocks perceived to be safe havens, with lower earnings volatility and higher-than-average dividend yields.↩
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