Outlook 2015: Chinese equities
Even as China's growth slows, long-term opportunities are present across a variety of industries.
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Chinese GDP growth in 2014 slowed as expected amidst economic rebalancing efforts and an anti-corruption campaign. Going into 2015, growth can be expected to moderate further against a backdrop of continued reforms and a property market slowdown.
As China works through its reform agenda, the initial and obvious opportunities around broader sectors and themes will make way for more discerning stock selection to drive longer term returns.
A benign liquidity environment with room for interest rate cuts (as we’ve seen recently) and targeted areas of policy support are also likely as China seeks to steer its massive economy away from the after-effects of its credit excesses but at the same time tries to avoid a financial crisis or destabilisation of the economy and broader society in the process.
The resolve in addressing China's imminent social and economic challenges is clear – even the Chinese Communist Party and its ruling elite are not spared – the ongoing anti-corruption drive has had a far-reaching impact. All this has led into the recently-concluded Fourth Plenum's focus on an overhaul of its legal system and rule of law, seeking to provide further legitimacy to the Chinese Communist Party as China liberalises its economy further along its path of restructuring and rebalancing.
Progress on reforms mixed
Progress on reforms so far has been mixed, and has been met with varying degrees of cynicism in the market, as well as success. Optimism over Sinopec’s initial state-owned enterprise (SOE) reform plans to bring in external partners for 30% of its marketing business faded when the end-buyers were eventually a group of 25 Chinese investors buying inconsequentially small stakes in the business. However, network infrastructure consolidation under a jointly-held company allowed for more efficient capital expenditure planning and allocation in the telecoms sector. Tariff deregulation and tax reforms have also allowed for more market-oriented pricing to take hold.
Reforms and policies will continue to feature significantly in China, and whilst we remain skeptical of the headline effects of SOE reforms, we can still expect to find select opportunities at the stock level – through evaluating the impact of policies and developments on specific businesses, instead of investing thematically and by sectors without delving into company specific dynamics and fundamentals.
Contrarian ideas look interesting
‘New economy’ companies – gaming and e-commerce players to internet and media companies – continue to generate strong growth as China's internet giants are increasingly dominant, with some even showing strong global ambition. Innovation and new technologies in the services sectors are fundamentally changing how the world goes about its day, from the purchasing behaviour of emerging market middle class consumers to the operations of global and multi-national corporations. Reflecting our positive view on China’s longer term consumption theme over the past two years in our portfolio strategy, some emphasis has been placed on investing in new economy companies, as well as in consumer and services-related industries including internet, pharmaceuticals and alternative energy.
The investible universe for China has been recently expanded further as domestic and more new China stocks have been made accessible through the launch of the Stock Connect scheme. However valuations here are often expensive and lofty, not dissimilar to their Hong Kong or Nasdaq listed counterparts – we will remain disciplined and look to re-position opportunistically on weakness.
Conversely, where we are finding value and are perhaps admittedly being contrarian is on retail and consumer plays. The onslaught of competition from e-commerce has left some of the brick-and-mortar retailers very unloved, trading below their asset values and at trough valuations. Within the segment we’ve sought out those that are able to adapt to this fast evolving environment, have strong balance sheets and are now at the end of their cost rationalisation processes. With much of the negatives already priced in, and as market share losses to e-commerce players stabilise and sales growth start to pick up, the coming year might hold potential upside surprises.
Risks from past excesses continue to lurk
Risks in the shadow banking system have not subsided. Economic growth has slowed in the wake of economic rebalancing and the anti-corruption campaign, and downward pressures on revenues and margins remain. The property sector continues to weaken outside the top tier cities as lower tier cities try to deal with the glut of supply from the over-investment and construction in recent years; leverage remains high for select property developers. However, the government has been obviously supportive given the sector's importance to China's overall economic picture - policies around mortgages for property buyers as well as funding for stronger property developers have been relaxed.
Save for a few headline defaults, loans look like they are being rolled over this year. A pickup in NPL (non-performing loans) and bankruptcies in 2015 are still therefore potentially likely scenarios, although we don’t expect this to lead to a widespread systematic risk event. These risks also imply that the liquidity environment will be kept relatively supportive, and selective policy action and support may be provided to steer a gradual deleveraging and adjustment away from the previous credit binge.
Changes are creating opportunities
Looking into 2015, we continue to find opportunities in insurance and consumption, as well as internet and services, as China tries to shift to a consumption-led economy, and are looking into nuclear energy related companies. Policy and governmental support will also continue to favour healthcare, environmental protection and clean energy related industries.
Additionally, the recently announced $40 billion Chinese-styled 'Marshall Plan' outlines China’s longer term political ambitions regionally and globally, as it aims to finance infrastructure projects in emerging countries through recycling of part of its foreign reserves. Select state-owned enterprises may benefit from these government-led initiatives in terms of opportunities for overseas expansion. We continue to maintain our positioning in railway equipment makers, and also see opportunities in other infrastructure related companies in the medium term.
Whilst the broader macro and policy-driven environment brings up interesting investment themes and ideas, our focus remains on taking a disciplined approach to active investing and selecting quality businesses with strong fundamentals. As China works through its reform agenda, the initial and obvious opportunities around broader sectors and themes will make way for more discerning stock selection to drive longer term returns.