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Year of the Dog: 14 voices on China's prospects

The rooster crowed, so now the dog must bark: seven investors give their views on China at the dawn of a new year.

The rooster crowed so now the dog must bark. Today is the first day of the Chinese New Year, as we transition from the year of the rooster to the dog.  

2017 was a particularly strong year for Chinese equites, but will the next 12 months leave investors barking with excitement or howling in despair?

The attributes we can look forward to, according to the traditional horoscope, include reliability, diligence and trustworthiness.

It remains to be seen if these are what we will remember the period for, however. Here, seven investors forecast their take on the year ahead.

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The rooster crowed so now the dog must bark. Today is the first day of the Chinese New Year, as we transition from the year of the rooster to the dog.  

2017 was a particularly strong year for Chinese equites, but will the next 12 months leave investors barking with excitement or howling in despair?

The attributes we can look forward to, according to the traditional horoscope, include reliability, diligence and trustworthiness.

It remains to be seen if these are what we will remember the period for, however. Here, seven investors forecast their take on the year ahead.

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Greg Kuhnert, portfolio manager at Investec

The seemingly frenetic activity around China’s emergence as a tech superpower is likely to continue into the Year of the Dog. E-commerce in China is already roughly double that of the US, with China being by far the biggest global market.

Mobile payments in China are 11 times that of the US ($790 billion versus $74 billion in 2016).

Meituan Dianping is the world’s largest online-to-offline (O2O) platform, which in 2016 sold $35 billion of services, such as restaurant and cinema bookings, and food delivery, to over 200 million customers.

Because of the huge size of the Chinese market, China's Uber, Didi Chuxin, has a domestic client base five or six times larger than that of its US rival. 

 

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Josh Crabb, head of Asian equities at Old Mutual Global Investors

As Chinese investors prepare to celebrate the Year of the Dog, the recent stock market correction has thrown up some appealing "underdog" opportunities – stock market laggards that should continue to benefit from the uptick in the Asian profits cycle.

Constituents of the Chinese bank sector have started to bounce from double-digit falls, while selected beneficiaries of the so-called fourth industrial revolution – the internet of things, artificial intelligence and 3D sensing - have once more, attracted buyers to the Asian region.

We believe, investors need to be selective here and not pay extravagant multiples for the dominant players in this area, but look at lesser known names such as Primax Electronics and Advanced Wireless Semiconductor.

Despite the recent rout in global equities, economic fundamentals look sound. Those investors who thought they had missed the rally in Asian equities at the start of the year, would do well to pick up some bargains.

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Ernst Knacke, fund research analyst at Quilter Cheviot

Chinese technology, e-commerce and consumer related companies were some of the standout performers in 2017, but we think there is still significant upside left for long-term investors.

The opportunity is underpinned by both fundamental and technical factors. Although well known, the sheer scale of China’s demographic tailwind is often misunderstood.

It is expected that over a million people will move from rural China into cities every month for the next four years, and this tech savvy generation will be at the forefront of global consumer trends.

Income per capita and wealth might still be low, but the fact remains that the rising middle class is vast, their wages are growing rapidly, and they seem to want to spend it!

 

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Gary Greenberg, head of emerging markets at Hermes Investment Management

Every dog has its day, but China has had a good several decades. While both EM and global investors remain substantially underweight and the market and short sellers decry the fragility of China’s model, 2018 should be yet another year when the dog of financial collapse does not bark and the market makes further progress.

This year, the fundamentals still look pretty good, despite the market trading at a modest premium to its long-term P/E. Thus, the market valuation is still sensible and the 2% yield provides solid support.

The economy should continue to grow at a good clip even if it slows down from 2017’s GDP growth rate of 6.8% to a more sedate 6.1%.

Importantly, the banking system is in much better shape than it was several years ago. The still healthy economy this year should result in earnings growth of about 14%, which should support the multiple of just under 13 times the consensus for 2018 earnings.

However, not everything is perfect; the investment in new industrial capacity will continue at a moderate pace. Mining and heavy industrial sectors will continue to show modest top-line growth and we expect exports to slow down as well.

Job growth will slow, mirrored by consumer spending. There are other clouds on the horizon: the US-China economic rivalry is about to heat up.

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Mark Williams, head of Asian income Liontrust 

We of course invest with a long-term time horizon and here we find that China’s growth prospects are huge. This potential is widely recognised, but perhaps underappreciated is the extent to which this process is in its infancy.

For example, we are already seeing Chinese consumption power have a huge impact globally through the 122 million Chinese who travelled overseas (in 2016), but 90% of China’s population still don’t own a passport.

Similarly, China is the world’s largest auto market, with car sales exceeding both Europe and the US, but there are still only around 21 motor vehicles for every 100 people (based on 2017 Ministry of Public Security data), compared to almost 80 in the US (source: World Bank 2010).

We shouldn’t make the mistake of thinking that the substantial consumption growth that has already fed through is anything more than the tip of the iceberg.

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Adrien Pichoud, chief economist at SYZ Asset Management

Over the last year, something peculiar happened, or rather did not happen, in macro discussions: China was barely a source of concern. GDP data, for what it is worth, was astonishingly stable, recording a real growth rate just below 7%. This allowed President Xi to open the Party Congress in October with the claim that economic objectives had been fulfilled.

Other data which look at manufacturing, services and industrial production have also been pointing to a stabilisation of growth after six years of slowdown. The yuan even appreciated against the US dollar in 2017.

Does this mean that all is well in the world's second-largest economy? Not quite, as China’s large and growing indebtedness level continues to threaten macroeconomic stability in the medium term.

So much so that right after the Party Congress, new measures aimed at cooling down leverage and credit growth were announced, prompting a temporary sell-off in Chinese equity markets and pushing government 10-year interest rates close to 4%.

Given its size and importance in the global trading and financial system, China cannot remain away from the headlines for long.

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John Lin, Chinese equity manager, AllianceBernstein

Once fully integrated into the global index, China A-shares are likely to account for more than 20% of the MSCI EM benchmark.

This process will take several years, but will incrementally attract around $100 billion of index-following assets.

Nearly 75% of EM mutual and index funds don’t hold onshore shares. China A-shares account for only US$14 billion (or 1.7%) of assets under management in EM funds. And only 10 EM funds hold more than 10% in onshore equities.

There are good reasons to be cautious. Investors need to navigate structural imbalances in China’s debt-laden economy, concerns about the government’s macroeconomic stewardship and the large contingent of state-owned enterprises in the market.

Ignoring them however, means missing the full potential of China’s expansion.

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Jorry Rask Nøddekær, manager of the Nordea 1 – Emerging Stars Equity fund

There are a lot of areas across emerging markets that are exciting us right now. We like to focus on identifying companies creating value and delivering strong profitability in what we call the major growth pockets. China is unquestionably among the areas in which we are identifying many growth opportunities.

We see a lot of potential in what we call ‘new China’ and we are particularly witnessing a lot of value creation in technology. Companies are becoming very innovative and fast-moving in this dynamic environment and we are seeing many opportunities in areas like camera technology for smartphones and the auto industry, as well as in 3D sensor technology. There are also opportunities in some world-leading e-commerce companies.

In the healthcare space, we believe we are getting close to an inflection point. Healthcare and healthcare services are really starting to take off and we see major monetisation potential for a number of companies in this sector. There are also some interesting consumer opportunities, but you need to be more selective, as it is an expensive area.

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Dale Nicholls, manager of Fidelity China Special Situations

Investments related to the rise of China’s middle-class consumer remain a core focus for me. These consumers are demanding more from products and services - and some companies are responding with strong offerings on both of these fronts.

I am constantly looking for investment opportunities in the health care sector given the strong mid-term growth prospects, and pharmaceutical distributors have emerged as an interesting area.

I own Sinopharm, China Resources Pharmaceutical and Shanghai Pharmaceutical due to their extensive distribution network and comparatively deep pockets.

Given recent regulatory changes and subsequent change in industry structure, this area has been neglected by the market and thus valuations look relatively attractive.

 

 

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Roberts Horrocks, chief investment officer at Matthews Asia

Fast economic growth can be volatile, with peaks and valleys along the way. China’s policymakers are trying to tackle this issue.

Quality growth, in our view, requires a large, consumer-driven marketplace, businesses that allocate capital efficiently and workers who feel part of a system that provides potential upward mobility.

Chinese domestic companies are developing robust consumer brands. In tandem, the Chinese government is focused on promoting higher quality management of businesses, while fostering more commercially and privately owned and operated organizations.

As active investors, we focus on high-quality companies that we believe will survive and can grow sustainably over the long term. We believe the future of China will be built on a stable economic engine, driven by consumer demand, private businesses making efficient economic decisions and an engaged working class.

 

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Ben Kumar, investment manager, 7IM

Chinese markets are slowly opening up to foreign investors, the Chinese government has joined the global political scene, and Chinese citizens are buying western goods, rather than the other way round.

We believe that the next 12 months for China are likely to see some volatility, as the government keeps undertaking structural reforms.

Our exposure to China, outside of our multi manager funds, comes through the MSCI Emerging Market Index; China is 30% of this, and is likely to keep growing.

Chinese equities have been incredibly strong performers over the last twelve months (with the consumer technology stocks such as Alibaba and Tencent seeing large gains), and we see no reason to be overweight the benchmark.

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Craig Farley, manager of the Ashburton Chindia Equity fund

As China celebrates entering the Year of the Dog, the Chinese leadership has shown its loyalty to improving the country’s economy.

The roadmap contains three core pillars of progress that should put the country on a more sustainable economic trajectory. Supply-side reform has focused on consolidation, removing excess capacity and reducing production volumes in key industries – such as coal and steel.

In these polluting industries, production is being cut further through the winter months in order to improve air quality, particularly in northern China. These cuts are benefitting the largest operators, improving profit margins as excess capacity is taken offline.

Meanwhile, the government is also focusing on deleveraging the more financially stressed areas of the economy. For example, the replacement quota model, which allows weaker and more inefficient producers to sell their capacity to larger operators, could be rolled out more aggressively.

The third pillar of the roadmap is the ‘beautiful China’ programme, which enforces the country’s environmental laws and regulations, incorporating pollution targets and related measures into provincial government KPIs for the first time.

In particular, the recent introduction of a pollutant tax at the local level should significantly increase local government revenues, while further driving consolidation in areas such as materials and energy.

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Ernest Yeung, portfolio manager, T Rowe Price Emerging Markets Value Equity fund

Financial markets and the Western media remain sceptical about China’s economic transformation efforts. However, we would argue that, while the world’s second-largest economy is facing a number of structural challenges, it is in a much better state now than at any time in the last five years.

The inflection point was Chinese President Xi Jinping’s understanding of the major problems facing China and the efforts he has made to tackle them during his first five years in office.

Investor attention in China over the past year has been largely focused on high-profile growth stocks – in particular the technology sector. This has meant many of the less dynamic, old-economy stocks have been largely ignored and are now trading at near historical lows. As such, we believe there are ample opportunities to be found in these areas.

Financials, industrials, domestic construction names and consumer staples companies are now visibly under-owned and fall within the ambit of old-economy stocks.

Indeed, these stocks are closely linked to the strength of the Chinese domestic economy, but still trade at relatively cheap valuations, only slightly above their levels during the global financial crisis.

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Bin Yu, senior portfolio manager and head of China equities group, Neuberger Berman

This year will be an important year for China, as the leading index provider MSCI is set to include onshore ‘A shares’ in its MSCI China Index for the first time.

This is a natural outcome of A shares becoming available to global investors through the Hong Kong ‘Stock Connect’. While we expect this move to have only a small initial price impact on the market, we believe its long-term implications may be considerable.

First, the change in index weights will compel benchmarked global investors to increase allocation to Chinese equities. Over time, we believe investors are likely to consider China equities as a separate asset class – similar to Japan equities today.

Second, we feel this development opens up access to the most relevant sectors in the China growth story: consumer sectors, industrials and healthcare.

Last but not least, we believe the decision will bring a different kind of investor base to A shares, accelerating the institutionalisation of the market.

New investors with longer-term views and a more fundamental analytical framework could become major shareholders of certain Chinese companies.

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