China was the best performing Asian stock market in 2017, and is one of the worst so far in 2018. Markets have corrected sharply this year amid renewed volatility, partly owing to worries about a Sino-US trade war. Until the trade talks reach a definite outcome, the ensuing uncertainty is likely to weigh on investor confidence.
However, the sheer size of China’s market and the growing role of domestic consumption is too large even for the US to ignore. Companies from both countries have seamlessly integrated supply chains and tariff-related disruptions will impact profitability on both sides.
We seem to be at an inflection point in Sino-US bilateral trade, with less inclination to cooperate than seen in the last decade. For China, it is also an opportunity to expand its presence in other ex-US international markets, as the momentum of innovation remains positive.
At the same time, Chinese policymakers’ recent attempts to deleverage the economy have been in the spotlight. Tighter liquidity, including the shutdown of shadow banking mechanisms, has affected credit disbursal in the real economy and exerted some downward pressure on activity (see related article).
Amidst dismal headlines about the US-Sino trade dispute and China’s deleveraging campaign, it is not unusual to see uncertainty dominate even as the underlying long-term growth prospects in China remain firmly in place.
The real economy is not as dismal as stock markets seem to suggest recently, but is more of a mixed bag. As China faces external uncertainty, it will respond with measures to stimulate internal growth, possibly through the route of fixed-asset investing. Long-term investors in China will find opportunities not only in the structural shifts but also among beneficiaries of reforms.
China has indeed entered a relatively low-growth phase of economic activity compared to a decade ago, but this has positive implications - the economy is likely to be less cyclical, and structurally it will be driven more by consumption than fixed-asset investment.
Source: China National Bureau of Statistics, Fidelity International, November 2018.
Corporates are focusing more on improving shareholder returns and enhancing dividend pay-outs. They are also increasingly acknowledging the importance of good governance and the social and environmental impacts of business. Chinese corporate balance sheets have significantly improved, companies are capex conscious and managements are adopting a more mature approach towards efficient capital allocation and reducing leverage.
Against this backdrop, Chinese equities provide attractive opportunities for bottom-up stock picking. Valuation premiums have retreated from peak levels seen at the start of 2018. There are opportunities in energy, industrials, high-quality real estate and select consumer-led areas of the market.