Charlie Awdry and May Ling Wee, China equity portfolio managers, provide a review of the market thus far in 2018 and discuss what may be in store for investors during the remainder of the year.
How have Chinese stocks performed so far this year?
The first four months of 2018 was a particularly volatile period (with sharp price movements) for Chinese equity markets. January experienced a brief up phase quickly followed by a sell-off, after the Chinese New Year Spring festival in February, which subsequently led to choppy and volatile markets through March and April.
These downward moves reflected a more cautious attitude, probably driven by increasing friction between the US and China on trade. The prospect of rising US interest rates also led to an increase in volatility in emerging equity markets as a whole. Additionally, investors have finally felt some indigestion over elevated valuations in the internet sector.
What is your outlook for the second half of 2018?
The purchasing managers’ index (PMI) surveys of businesses activity and the tighter monetary conditions in place since the tail end of 2017 suggest we may have seen a peak in Chinese economic activity.
The stronger financial regulations being imposed on the “off bank balance sheet” lending industry (lightly regulated lending mainly by trust companies, brokerages and insurance companies) is hurting weak corporates, while compliance with tougher guidelines has been pushed back to the end of 2020 to allow for a smoother transition. These financial reforms are painful but necessary as China looks to shift its growth model and wean itself off debt.
We think strong corporate profitability and cash flows, together with early signs of monetary easing and falling interbank lending rates, should provide an economic cushion. Meanwhile, currently low valuations are supporting many ‘old economy’ stocks, such as energy and minerals, in the Chinese markets.
Where are the most rewarding investment opportunities likely to be?
In our view, ‘new economy’ stocks, such as those in the consumer-driven and service sectors, may be more affected by their specific profit growth outlooks and this will likely require strong stock selection. This is different to 2017 where simply an allocation to China was the key to successful investing. We find opportunities in selected consumer-driven growth companies at reasonable valuations and unloved but cash generative state-owned ‘old economy’ companies in sectors such as energy and materials.