In this Q&A, Charlie Awdry and May Ling Wee, Portfolio Managers for the Chinese Equities strategy, share their thoughts on the key challenges and opportunities that investors may face in China in 2020 and how 2019 has influenced their outlook for the asset class.
- We believe trying to anticipate the nearer-term outcome of U.S.-China trade talks is futile; the strategic rivalry between the two nations remains an ongoing issue.
- In our view, the bedrock of the China investment case remains the consumer, with potential opportunities in internet services, health care and life insurance.
- 2019 has shown that China’s leading companies can perform well despite a weaker, more challenging macro environment.
What main risks should equity investors be aware of in China in 2020?
Quid Pro Quo Retaliatory Action: We think there is ultimately no easy resolution to the strategic rivalry between the U.S. and China. Reescalation of the trade and technology wars can happen at any time. The issue is a difficult one for investors to navigate, especially when the U.S. has many nontrade levers to pull. The trade war not only hurts China and the U.S. but also the global economy, as well as net inflows to Chinese investments.
Hong Kong and the Communist Party’s Reaction: The China Politburo Standing Committee’s stance toward the challenge to their authority appears to have hardened, suggesting that Hong Kong’s institutions and corporate sector could become more centrally controlled than before. It could erode Hong Kong’s status as a separate jurisdiction under the Basic Law1 and its role as a global financial center. The U.S. Senate passing the Hong Kong Human Rights and Democracy Act will only add more complications to U.S.-China relations.
Small Bank Bailouts: Smaller regional banks in China continue to face liquidity challenges, especially in the aftermath of three regional bank defaults this year; the implicit guarantee of previous bailouts has been removed. While China’s large banks are relatively well capitalized, there is a possibility that they can be called upon to rescue failed smaller regional banks.
What may be in store for 2020?
Growth at a Reasonable Price in Mega-Cap Internet Stocks: Growth shares, especially in the Chinese health care and consumer sectors, have performed well year to date as investors seek out stable, sustainable growth. Today, several mega-cap internet companies, which continue to innovate to meet the needs of Chinese consumers and businesses, are trading at below average price-to-earnings (P/E) multiples.2
Possible Cyclical Bottoming If Easing Steps Up: While it is likely that China’s growth will slow into year-end and early 2020, the expectation is for the government to step up both fiscal and monetary easing3 to stabilize growth. Rate cuts (to lower borrowing costs) have been put in place but have yet to translate into an increase in the volume of credit. If credit volumes rise, infrastructure investments climb and business confidence strengthens, we could see a possible near-term cyclical bottoming in the economy. In our view, this is likely to be a supportive backdrop for China’s leading industrial and consumer cyclical companies (that tend to be more sensitive to changes in the economy) that we think are attractively valued.
Which key themes should be considered when investing in China?
Consumption and Services: Our view remains unchanged: The Chinese consumer is the foundation of the investment case in China. Companies that can provide the right products and services to the consumer win “mind and wallet” share. The Chinese consumer is becoming more discerning; innovation by large internet service companies allows them to meet the needs of the consumers that form China’s roughly 850 million “netizens.”
Opening Up of Financial Markets: China wants to encourage foreign investment into its equity and bond markets. Global allocations to the Chinese asset class are likely to continue to increase given the inclusion of China A shares in the MSCI Emerging Markets Index last year. Through both the Shanghai/Shenzhen Stock and Bond Connect,4 the Hong Kong Stock Exchange (HKEx) continues to provide a convenient means to access local asset markets. HKEx could also benefit if more Chinese companies choose to dual list (in both mainland China and Hong Kong), favoring HKEx as an alternative listing to American depositary receipts (ADRs),5 where compliance with U.S. regulatory and securities requirements is mandatory. HKEx would then be the default overseas market, where the global pool of capital is sufficiently deep for Chinese companies to raise funds. A case in point is Alibaba’s decision to pursue its secondary listing in Hong Kong.
Life Insurance and Health Care for an Aging Population: We believe China’s aging population’s collective wealth creates opportunities in service sectors, such as life insurance and wealth management. Insurance penetration is low in China. For the maturing workforce and China’s many increasingly wealthy entrepreneurs, the desire for wealth protection and asset growth is becoming stronger as these groups consider generational transfers of wealth and retirement needs. Likewise, the rising silver dollar will be spent on health care products and services.
What lessons can be learned from 2019, and how have they shaped your outlook for the year ahead?
The past year has made it evident that trying to second-guess or anticipate the outcome of trade talks is futile. The market has been disappointed on a few occasions this year.
In our experience, investing in China is always a confluence of macroeconomic and microeconomic factors. The CSI300 Index has gained 28% year to date while the MSCI China Index has risen by 11% over the same period.6 This has happened despite the continued and sustained downtrend in the macro economy. It is the expectation of the government’s attitude and willingness to support the economy that determines market sentiment.
This year, macro and micro appear to have decoupled again. It also highlights that China’s leading companies have done well, both operationally and in terms of stock market performance, despite a weak and challenging macro environment.
While we acknowledge that China’s growth will slow after 30 years of rapid growth, we continue to think investors can find opportunities as China’s leading companies innovate, develop new market opportunities, and offer better products and service offerings for their customers.
Which market trends should investors
watch in the year ahead?
1Basic Law: The “one country, two systems” principle is enshrined in the Basic Law document, which applies to Hong Kong until 2047. It protects rights such as freedom of assembly and freedom of speech and the territory’s governance structure.
2Price-to-Earnings (P/E) Ratio measures share price compared to earnings per share (EPS) for a stock or stocks in a portfolio. P/E is expressed as a number or a multiple of EPS and is an important indication of comparative value for investors.
3Fiscal and monetary easing: relates to polices designed to stimulate the economy; this can either be fiscal where governments spend more or tax less, or it can be monetary whereby central banks use tools such as lower interest rates or asset purchase schemes.
4Shanghai/Shenzhen Stock and Bond Connect: collaboration between the Hong Kong, Shanghai and Shenzhen Stock Exchanges and China’s interbank bond market. The market access schemes allow international and mainland Chinese investors to trade securities in each other's markets through the trading and clearing facilities of their home exchange.
5American depositary receipt (ADR): a certificate representing shares of a foreign stock owned and issued by a U.S. bank. ADRs facilitate the trading of foreign-based companies’ shares in U.S. stock markets.
6Source: Bloomberg, index price returns are from 12/31/18 through 12/4/19. The CSI 300 Index is a capitalization-weighted stock market index designed to replicate the performance of the top 300 stocks traded in the Shanghai and Shenzhen stock exchanges. The MSCI China Index measures large and mid-cap representation across China securities listed on the Shanghai and Shenzhen exchanges. The index covers only those securities that are accessible through "Stock Connect."
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