Mirae Asset’s Rahul Chadha reviews expectations for China through 2014
Rahul Chadha, co-CIO of Mirae Asset Global Investments, has looked at some of the macro and micro factors that will affect returns from investments in China this year.
China is currently undergoing a profound transition. With growth becoming less dependent upon internal investment and more focussed on consumer spending, in addition to promises of sweeping social and economic reforms following the Third Party Plenum Session in November, investors should focus on companies with scalable business models that are well placed to rapidly expand capacity in the coming years. These future ‘sector leader’ companies are exceptional investment opportunities, but require unparalleled local knowledge to make the right call.
2013 was a year in which central banks played an extraordinary role in influencing global markets. The start of the year was marked by an unprecedented loose monetary policy by the Bank of Japan, mirroring the actions of the US, triggering sharp depreciation of the Japanese Yen and strong outperformance of the Nikkei index. In mid-year, domestic demand led economies with current account deficits, such as India and Association of South East Nations (ASEAN) countries, were challenged on fears of tapering of the US Federal Reserve’s QE program. Throughout this period China continued to experience sharp volatility between fears of a hard landing and optimism for reforms led by the new leadership.
After a year of fear, doubt and hope, market consensus for China’s 2014 GDP growth has converged towards the mid 7% level, similar to that of 2013. This can be interpreted that the market has ratcheted down its expectations of what was once high growth to a more modest, but still healthy, level. China’s economic data from the past several months suggest that the economy has stabilized and inflation has been maintained at a manageable level. At the same time, positive developments in recent months on the reform front suggest that the government is focused on, and making progress with, rebalancing its economy to achieve a more sustainable and higher-quality growth trajectory.
As such, the main difference in the outlook for China’s economic growth in 2014 compared to 2013 is the mix of growth drivers. In 2013, fixed asset investment growth remained strong, mainly driven by infrastructure and property investment. Consumption growth has been stable while export growth was relatively weak. However, based on signals from the Third Plenum Session, in 2014, investors should expect contributions from fixed asset investments to gradually weaken as no major government investment is expected. Consumption is likely to expand at a stable pace of low to mid-teen levels and exports will improve compared to last year’s levels as the overall global economic recovery continues.
As such, the global economic recovery will be a key external positive catalyst for the Chinese market in 2014. Though slower than expected, the US and EU economies are on the road to recovery. This uptrend should hopefully continue throughout 2014, providing improved conditions for export growth and investment sentiment in China.
Moreover, positive economic recovery trends may reverse the recent fund flows, which have been concentrated in the developed markets, back into the emerging markets, including China, as investors search for greater growth leverage.
Moving beyond existential factors in China’s growth story, it is important to note that expectations for reforms remain high after the end of November’s Third Party Plenum Session, a gathering of China’s 400 most powerful leaders in Beijing.
Though detailed plans to the reforms have yet to be announced, the session ended positively with the promise of sweeping social and economic reforms.
Of particular note are moves to share more tax revenues with local governments, encouraging investments into the private sector and relaxing the single child policy would help correct some of the imbalances in the economy.
Additional market-opening reforms aimed at stimulating the economy include the liberalisation of pricing across the water, gas, energy and land industries, whilst plans to liberalise interest rates and improve the Renminbi exchange rate formation mechanism will have a profound effect on Chinese securities.
What does this mean for investors?
In the coming quarters, hopes of reforms combined with the government’s efforts to shift away from investment-led growth may lead to investors accepting lower but more sustainable levels of growth. Meanwhile, low unemployment levels and rising wages will further reinforce this shift.
As a result, there are likely to be significant opportunities in the medium term in consumption focussed industries such as Internet, mobile technology, healthcare, travel and leisure, as well as the beneficiaries of an increasingly green China.
Within these sectors, the most compelling companies are those with scalable business models and an unrivalled execution capability. As the Chinese consumption story becomes increasingly mature, these companies will be best placed to rapidly expand and dominate market share.
However, attempting to predict future market leaders is a difficult endeavour. Investors that are best placed to succeed will have on the ground knowledge to effectively gauge trends in consumer behaviour. On the ground investment knowledge will enable investors to spot consumer trends and companies gaining traction and brand recognition.
Whilst 2013 was a mixed year for Chinese investors, the improving global outlook and domestic reform agenda is likely to result in numerous opportunities for investors with the local nous to spot tomorrow’s winning companies.