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Year of the Horse: Is China worth a bet?

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29/01/2014
With Chinese New Year celebrations kicking off this week, it may be a good time for investors to think about their allocation to the world's second-largest economy.

China has experienced phenomenal economic growth over the past few decades. But a period of slower growth has left investors anxious.

Just last week, the Hong Kong Hang Seng Index fell to its lowest level in five months as jittery investors withdrew capital amid renewed concerns over a further slowdown, default risks and tightening monetary conditions.

However, official data shows China’s economy is starting to stabilise. It grew at an annual rate of 7.7% between October and December and while this was down from 7.8% in the three months to the end of September, it was still higher than the government’s 7.5% target.

In addition, since taking office last year, President Xi Jinping has announced a raft of economic reforms which, if implemented successfully, could be enormously transformative and open China to further social and economic reform, and interestingly for investors, new sources of private sector-led growth.

However, experts are cautious over the “ambitious nature” of the reform package and the time it will take to implement the proposals.

Dean Cook, investment research analyst at Duncan Lawrie Private Bank, says: “The extent of China’s social reform is going to be a leading factor in identifying what investment opportunities there are in the country. As we enter the Year of the Horse, equine allusions will inevitably be drawn: will the economy fall at the next reform hurdle?

“At the Communist Party Congress in November last year, it became clear just how serious the Chinese administration is about reforming its economy and allowing it to be led by market forces rather than central government edict.

“However, as with most emerging markets, we must approach announcements about economic and social reform with a degree of caution. Given China’s size, it cannot overhaul its long-established institutions overnight.”

The government also has a number of crucial tailwinds to tackle before investors can feel confident that China is on the path to stable economic growth.

One concern is the further stress the reform package will put on government debt levels, which have built up after the first stimulus package in 2009 following the financial crisis, and when China’s economy required increased stimulus in 2012 following flagging growth in Europe and a slower than expected recovery in the US.

China’s runaway property prices are also a sore point, with many residents already priced out of the market and forced to pay high rents.

But Cook points out that the Chinese government is aware of the issues that it needs to tackle: “Already, local government finances are coming under greater supervision and the central Government is working hard to improve oversight, including the introduction of a credit rating system for local governments.

“The Chinese Government clearly recognises the challenges ahead, and will focus on growing debt at a slower rate than economic growth, in order to bring debt under control.”

 

While Beijing looks to get its house in order, Tom Stevenson, investment director at Fidelity, thinks that there are opportunities for the brave investor.

He says: “The reasons I am still positive on China despite the obvious concerns that people have about its property market, banking sector and growth slowdown are these. First, I think the reforms initiated last November are a very positive development for the country which will set it on a path to a lower but more sustainable growth path. It will be one that is less dependent on capital investment and exports and more geared to domestic consumption. That shift creates many opportunities for stock-pickers looking for the winners in retail, the internet and service sectors.

“The other main reason for being positive on China is its valuation after two years of severe underperformance. Its shares on average trade at around nine times earnings, which is much lower than many other markets, both in the developing and the developed worlds. In other words the bad news is already priced in. When sentiment is as poor as it is towards China today, this can often represent a contrarian buying opportunity.”

China’s steps to address its well-publicised pollution problems may also highlight opportunities in the alternative energy space in both wind and solar, predicts Andrew Swan, manager of the BlackRock Asia fund.

Consensus is that China is on course to become the world’s largest economy within the next few years, possibly making exposure to it prudent for investors looking for a balanced portfolio with a global outlook.

Cook adds: “Everything points to the fact that in the short term China needs to get its house in order. But with economic, social and legal reform on the horizon, we would hope for a more positive outturn in the longer term. In the short term, China may be slow out of the gate, but the race is long and as it starts to gather pace, it may be worth a bet on the nose.”

 

 

China fund picks…

Darius McDermott from Chelsea Financial Services likes the Fidelity China Consumer fund.

He says: “Whereas in the past, materials, energy and industrials benefited from China’s rapid expansion, the manager is looking at ‘New China’ sectors which should benefit from the changes ahead, for example: consumer discretionary, IT, insurance and healthcare.

“These new sectors have substantial room to grow as the economy develops and my personal view is that, while luxury brands have been the story for some time, I think the next real opportunity in China will come from a more moderate level, as the working and middle classes look to purchase affordable products and services.”

McDermott also likes Invesco Perpetual Hong Kong and China. He says the manager has a very disciplined and risk averse approach to investing which has worked well for him in this market.    

  

 

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