No ‘pig of a year’ for investors looking to China
As China celebrates its New Year, many investors will be hoping the Year of the Pig doesn’t live up to its name – and the expectation is that it won’t.
Like most of the world’s capital markets, Chinese stocks ended 2018 on a sour note, with both the Shanghai and Shenzhen stock indices slumping into bear market territory for the year at -25 percent and -35 percent, respectively.
‘Just as there were several contributing factors to the remarkable returns seen from Chinese and wider emerging market equities in 2017, so 2018’s difficulties stem from a variety of sources,’ observes Will Hobbs, chief investment officer at Barclays Smart Investor, in a statement.
The most-cited cause of the trickier investing backdrop is, of course, the much reported US-China trade war. ‘Any story involving the 45th president tends to draw readership, particularly those in which he is perceived to be destabilizing the old world order as promised on the campaign trail,’ Hobbs notes.
But just as likely – if not more important – to 2018’s woes was China’s mostly deliberate economic slowdown, a function of the administration’s continuing attempts to contain financial stability risks, adds Hobbs: ‘Alongside this came moderating earnings expectations from previously elevated levels at the major Chinese tech companies.’
This can be seen as resulting in a positive market outlook for investors. ‘Given the scale of last year’s capital markets’ carnage, we think a lot of bad news has been priced into the stock market,’ Hobbs notes. ‘In our view, there remain good reasons for a medium-term allocation to the Chinese stock market within a globally diversified portfolio.’
Delving deeper, there are, for Hobbs, three elements to this appealing investor scenario. First, the ‘pullback’ has brought Chinese stock market valuations to a more attractive level, with valuations looking reasonable enough to provide decent upside over the medium term.
Second, he thinks the top constituents within the Chinese stock market – mainly tech and financial companies – are still well placed to benefit from China’s structural shift toward a consumer and services-driven economy.
Third, the Chinese stock market provides important diversification benefits in the context of an overall investment portfolio, which, more often than not, is heavily tilted toward developed market assets.
Kim Catechis, manager of the Legg Mason IF Martin Currie Emerging Markets Fund, also notes how the trade war narrative has overly dominated the China investment outlook. ‘When it comes to China, investors have perhaps been narrowly focusing on the fact that it is currently at loggerheads with the US over trade, and growth has slowed,’ she says.
But Catechis adds that investors should not forget factors such as the One Belt, One Road initiative – a wide-ranging Chinese government infrastructure development and investment project – launched in 2013. ‘A showcase of its geopolitical strength, [the initiative] is a reminder of the growing importance of China’s markets beyond the US. The project remains a major force for growth both in China and across emerging markets and, as we enter a new year, it should not be overlooked,’ she says.
‘Certainly, in terms of sheer volume of infrastructure investment and the potential for increased connectivity across the region, the project remains as vital today as it was when first launched.’
From a portfolio perspective, Catechis believes this continues to be a driver of some compelling opportunities: ‘Perhaps most interesting will be the ‘users’ of this infrastructure – companies whose markets will expand as a result – and therefore provide them with opportunities for top-line growth.’
Critically, she points out that this ‘transcends the physical realm. The positive impact of the Digital Silk Road, which complements the more headline-grabbing land and sea links, should not be underestimated. Companies like Chinese commercial bank ICBC, which will be at the vanguard of funding the project, and e-commerce giant Alibaba should be major beneficiaries of greater connectivity in the countries concerned.’
Hugh Sergeant, manager of the London-based River & Mercantile Global Recovery Fund, agrees that on a mainstream equity level there is reason to be optimistic. ‘I have argued for some time that Chinese equities look very cheap,’ he says. ‘We continue to look for de-rated digital economy stocks in particular, and China remains a very fruitful hunting ground for these given that valuations have fallen to 10-year lows.’
‘Ultimately, we see investors being best served by remaining focused on the long-term prospects of the Chinese stock market,’ notes Hobbs. ‘The tumble dryer of the short term can be disorienting, but in reality serves primarily to provide an attractive long-term entry point for the level-headed investor.
‘We think the level-headed investor will still find the Chinese economy has enormous potential to grow and mature over the coming decades, with Chinese companies well poised to take advantage of this. As such, we think Chinese equities retain decent upside potential over the medium term, warranting a place within globally diversified portfolios.’