Chinese equities
25 Nov 2019

Avoiding the sidelines in China

China equity valuations are supportive, the country’s growth story is compelling and we would expect to see investors increasing their weightings

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Headlines may be keeping some international investors on the sidelines. We would argue that China deserves a more nuanced approach, however.

After all, the country’s stock market is equal in size to Europe’s and offers ample opportunities in the form of some very good companies thriving in a vast economy, the government committed to introducing economic reforms and capital markets becoming more accessible for global investors. Consider that:

  • Valuations aren’t particularly challenging, with the Shanghai’s large-cap SSE 50 index trading on a price to forward-earnings ratio – the share price divided by expected future earnings per share – of 9.9 times, below the average since 2001 of 11.8 times 9x forward earnings, below the average since 2006 of 11.8x[1]
  • China’s domestically listed stocks have rallied, with the CSI 300 generating better returns this year through October than the S&P 500 and MSCI World[2]
  • Policymakers cut rates in November and announced a series of supportive measures in Q3, including reducing banks’ reserve requirements
  • Index provider MSCI has boosted the weightings of China A shares in its global benchmarks, to 4% in the MSCI EM index, vs 2.5% previously[3]

While growth has been under pressure from internal and external headwinds it remains robust by global standards. The crackdown on the shadow banking sector and a drop in productivity efficiency had an impact on growth last year. We expect China will be successful in aiming to keep credit growth steady and in implementing various reforms to boost productivity. 

 

 

China is rebalancing toward a consumer- and services-led economy from one based on industry and export. Think of it as a move towards quality-led growth from quantity-led. The quality of growth should improve based on all the reforms underway right now such as tax system changes, reforms to state-owned enterprises, market liberalisation and greater innovation.

We believe China assets become more attractive as the economy rebalances, with potential for higher returns on equity and better revenue as capital expenditure requirements ease, including improved cash flow and dividends.

There are high-quality companies with strong fundamentals in the consumer, healthcare, utility and financial sectors.  Taking healthcare as an example, spending in the sector is expected to grow faster than the underlying economy over the medium term as incomes rise, the population ages and the government reforms the health system.

Don’t forget the demographics of Asia’s largest economy: 1.4 billion people increasingly urbanized with a growing middle class. China’s GDP per capita of around US $10k[1], lags that of many developed countries and highlights upside in the value chain.

Markets Opening

China is keen to attract more international capital and has begun to speed the opening of financial services to foreign companies. This includes allowing international financial firms to become majority owners of local joint ventures. The Stock Connect programme, collaboration between the Hong Kong, Shanghai and Shenzhen exchanges, allows international and mainland Chinese investors to trade securities in each other’s markets through their home exchange. The London and Shanghai exchanges launched a Stock Connect link in June.

The trade war with the US has been an external headwind and has generated periods of market volatility. However, at the time of writing there are signs of progress in talks. The Chinese have used reforms, stimulus and fiscal resources to help protect growth. 

We believe the China growth story is compelling over the medium and long term, and it’s supported by government policy and relatively attractive valuations. We would expect to see investors increasing their weighting to China substantially in the next five years. It’s not the time to be on the sidelines.

 

[1] Bloomberg as at 8/11/2019

[2] Bloomberg as at 5/11/2019

[3] Morgan Stanley, as at 8/11/2019

[4] Source: World Bank data for 2018.

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