Those born under the year of the rooster are known for the ease with which they catch the eye and Chinese equity investors will be looking to the new US administration for direction in the coming months.
President Donald Trump’s current stance suggests possible trade differences with China, but, in reality, this remains something of an unknown and we are taking a wait and see approach to his presidency.
This does not change our headline view – we remain positive in our outlook for the Chinese equity market. We are, however, moving away from exporters until there is some clarity from the new US administration.
Uncertainty over the future trading relationship with the United States spread unease through the Chinese equity market and consequently 2016 ended on something of a sour note.
The MSCI China Index fell by 8% for the fourth quarter and has been treading water in the opening weeks of 2017. Prudent stock pickers will understand that much of this can be put down to sentiment and the sense that the geopolitical shocks of 2016 have made forecasting for 2017 little more than a guessing game.
What we do know is that currency moves, trading relationships and geopolitical tensions are all areas of uncertainty in the year of the rooster.
The fate of reform
Uncertainty does not just emanate from external sources but from internal ones too. The fourth quarter’s 19th Party Congress could end with a new leadership team in place, potentially heralding changes to Xi Jinping’s economic reforms.
The latest of these are the supply-side and SOE (state-owned enterprise) reforms that began with an end to the one child policy at the beginning of 2016 and have been rolled out further since.
Such initiatives should stabilise and enhance economic growth in the long term, though their immediate and more eye-catching impact on credit and employment growth is likely to be shorter lived.
Lowering business costs, financial deleveraging and cutting excessive capacity also led to an earnings turnaround for many companies in late 2016. How sustainable this is and the longer-term growth benefits for individual companies are not yet known.
Monetary easing to boost the economy is likely to wind down further this year. That being said, more aggressive government spending and special bond issuances, as well as PPP (public-private partnership) projects, will continue to see new money pumped into the economy, especially in the first half of the year.
We see many industries continuing to benefit, as infrastructure projects take off and stimulate demand in the materials and construction industries. We are aware, however, that president Jinping’s efforts to both strengthen reform execution and introduce new initiatives could be hurt by geopolitical tensions.
We will be watching all of these issues closely and using any volatility to select stocks with positive growth prospects on attractive valuations. After all, uncertainty can breed opportunity.
In with the old and in with the new
Our focus in recent years has been on those companies likely to benefit from the changing nature of China’s economy and the growing services sector. This year, though, we are striking more of a balance between such companies and the more traditional, cyclical industrials and materials companies that have dominated the Chinese economy in past years.
We have already touched upon the supply-side reforms designed to deal with issues such as overcapacity. These efforts, together with more aggressive fiscal spending and re-stocking, are generating positive momentum for the likes of the coal, steel and cement industries.
Re-stocking in response to new infrastructure projects is also taking place in everything from construction materials to heavy duty machinery. We will be watching closely to see if this momentum can be sustained in the second half of the year, as companies will be operating from a higher base and external pressures on the Chinese market may begin to take their toll.
If the success of supply-side reforms is more long term, there is every chance that the long-term growth prospects of these companies could receive a significant boost. And this is why we are more constructive on the cyclical industrials and materials sectors than we have been in some time.
In addition, we remain champions of the beneficiaries of rising consumption, and the technology upgrade and industrial automation trend in China. The domestic consumption upgrade story is still playing out, which remains a positive for domestic-focused businesses, and inflation is likely to make a moderate comeback this year too – a boon for those companies with the pricing power to benefit.
Some “New China” brands, however, may find it harder to justify their current valuations in a volatile market, which demand a substantial and sustainable level of growth. Nonetheless, any sell-off in the market this year is going to open up opportunities in quality, if currently expensive, companies.
A strategy ready to face the challenges ahead
We will have to wait and see what Trump’s stance on trade will be and whether Jinping’s supply side reforms really do stabilise growth and boost the domestic economy. And there will undoubtedly be volatility along the way.
Regardless, our balanced, bottom-up stock selection process has found domestic opportunities in both the new economy of China and traditional cyclical sectors that are seeing a turnaround in earnings expectations.
We think such a balance is important in a time of uncertainty. With valuations at a reasonable level, we believe the companies we are invested in have the potential to deliver strong returns over the medium to long term.
Laura Luo is head of Hong Kong China Equities at Barings