Considering reform versus growth in China
In 2014 Chinese equities have largely been driven by sentiment and the government’s constant tug-of-war between its reformist agenda and the quest for growth, rather than pure fundamentals.
The recent interest rate cut by the People’s Bank of China was surprising as we believe the slowdown in the country did not warrant such an aggressive move. There continues to be conflicting messages as to whether the Chinese government is more focused on reform or growth. At the beginning of the year, the government was quite keen on reforms at the expense of slower but more sustainable growth. But it appears that the government has slowly introduced mini stimulus and easing of various forms since then. In terms of reforms, we think this will have to encompass a reorganisation of the state-owned enterprises (SOEs), as well as financial, fiscal and land reforms. So far, the market appears to be fixated only on SOE reform but to us, financial, fiscal and land reforms are even more important as they are crucial to the sustainability of China’s growth going forward.
The interest rate cut could be seen as part of the rates liberalisation battle, which will benefit the economy in the long-term but will mean a higher cost of capital in the short-term to help balance over-investment in the past decade and rising consumption. Market liberalisation will benefit consumers but will have a negative impact on corporates, particularly highly leveraged ones.
Despite the beta-driven rally in China in the last few weeks, investors have to be more discerning with stock picking if they were to look beyond a few months in terms of time horizon. For example, the Macau gaming sector was a significant holding in our portfolio, but we have tactically reduced exposure as we have found more attractive opportunities in areas like e-commerce and tech hardware. There have been a lot of challenges for the Macau sector this year, including the anti-corruption campaign, the smoking ban and the tightening of transit visas, all of which have changed the mix of gamblers visiting the city. However, with the recent relaxation in terms of the border crossing and the development of surrounding theme parks, we still believe in the long-term story as the growing middle class in China embraces gaming as a form of entertainment.
We continue to be excited about the technology space due to the growth in areas such as the internet and particularly mobile internet consumers. E-commerce companies have been very successful in leveraging the domestic ecosystem, which has a poor physical retail infrastructure, and is benefitting from the proliferation of very cheap smartphones. The same goes for social media, which provides users with unprecedented ability to communicate as well as various forms of entertainment.
We have built up our A-share exposure through the Shanghai-Hong Kong Stock Connect programme and managed to profit from the 35%+ year-to-date rally in the A-share market. As the A-share markets open up and the government promotes the rejuvenation of domestic equity investments, we believe there will be a structural re-rating of A-shares. The fund currently has around 6% exposure to A-shares across eight names, in names and sectors that are largely unique to A-shares. If the market pulls back we will look to add further to exposure in specific names we find attractive.
Michael Lai is investment director at GAM