Fears of a hard landing in China are now being replaced by renewed optimism about the recent performance of both the country’s economy and its equities markets.
Contrary to speculation, China’s “economy is far from contracting,” says Mark Grammer, senior vice president of investments with Toronto-based Mackenzie Financial Corp. and lead manager of Mackenzie Universal Global Growth Fund. In fact, Grammer expects China’s gross domestic product “to grow in the 8%-8.5% range” this year.
Concerns about China’s economy had emerged in some circles when its official GDP growth target for this year was reduced to 7.5% from 8%, which compares with 9.2% GDP growth in 2011, says Agnes Deng, co-portfolio manager of Excel China Fund and head of Hong Kong equities with Baring Asset Management (Asia) Ltd. in Hong Kong.
This target, the first reduction in seven years, she adds, “sends a strong signal” that China’s government is focusing more on the sustainability and quality of growth rather than the magnitude – a prudent strategy, given the sluggish pace of growth in many of China’s traditional export markets.
Nevertheless, the importance of exports to China’s economy is declining, with a lower percentage of exports going to the conventional U.S. and European markets. Mark Mobius, executive chairman of Franklin Templeton Investments Corp.’s emerging markets group in Singapore and lead manager of Templeton Emerging Markets Fund Inc., argues: “There remains a common misperception of China being predominantly an export-driven economy, but this is not actually true. In 2011, domestic investment and local consumption together contributed US$6.8 trillion to the economy, compared with US$2.1 trillion from exports. [As well,] the export of goods and services as a percentage of GDP is expected to fall to an estimated 28% in 2012 from 38% in 2007.”
In essence, China’s government has been boosting fixed-asset investments and domestic consumption to offset the decline in export growth since 2008, says Benjamin Tam, assistant vice president and portfolio manager with I.G. Investment Management (H.K.) Ltd. in Hong Kong and co-manager of Investors Greater China Fund.
In fact, says Grammer, last year saw 25% growth in fixed-asset investments in areas such as basic infrastructure, capacity-building, railways and manufacturing, as well as a 17% growth in consumption. He contends that these developments offset the government-initiated slowdown in the private-property sector, aimed at preventing a housing bubble.
The government also has taken several measures to curb rising inflation, Grammer says, putting those investing in China on guard. These include increasing the banks’ cash reserves ratios to manage liquidity in the banking system and raising key interest rates.
Although there are concerns about inflation – primarily due to higher food prices and rising wage and input costs – that is now less of a risk. Tam points out that real growth in China’s consumer price index was at 3.2% in February vs the government’s target of 4% for 2012. However, he cautions, the inflation rate typically falls in the first half of the year before picking up in the second half; thus, he forecasts the 2012 annual rate to be in the range of 3.6%.
China’s strength comes from the fact it “has one of the world’s largest stores of foreign reserves,” Mobius says, which allows it to support economic development and “makes it less vulnerable to external financial shocks. [Also,] foreign direct investment continues to grow, as international investors remain attracted to China’s booming economy.”
Fund portfolio managers suggest that positive developments in China far outweigh negative sentiments, making China an attractive investment opportunity. The MSCI China index is up by 18% in U.S. dollars for the year ended Feb. 29, following a loss of about 20% last year.
“Share price valuations remain at the lower end of historical ranges,” says Deng. “This represents an attractive opportunity for investors to participate in a multi-year growth story at a low entry level.”
Adds Mobius: “The MSCI China index is trading at a 12-month forward price/earnings multiple of 9.7 times, which is lower than the MSCI emerging markets index’s P/E of 10.4 times and the MSCI world index’s P/E of 11.8 times.”
And Tam notes: “The average P/E ratio in China is 12.5 times for the past 10 years.” He adds that equities have room for growth.
Stocks in China-based companies “are cheap relative to the potential growth rate” of these underlying companies, Grammer contends, which, in general, have “strong financials, low debt/equity ratios, increasing return on equity, reasonably rapid sales growth and growing bottom lines.”
There is consensus among fund portfolio managers that the retail sector presents significant opportunities.
Mobius favours firms producing both disposable and non-disposable goods, electricity providers, material suppliers and other industries that support and benefit from consumer demand. He also looks for opportunities in banking, as well as in energy, mining and agriculture.
In addition to consumer goods, Deng likes jewellery retailers and favours certain technology and materials companies.
Tam prefers automation, financials, infrastructure, information technology, health care, new materials, environmental protection and energy-saving technologies.
Grammar is partial to Inopec Group, the state-owned petroleum and petrochemical enterprise; China Mobile Ltd., the state-owned telecommunications company; and Singapore-based China Minzhong Food Corp. Ltd., which has good expansion capabilities in China. The Mackenzie fund also is invested in foreign companies that have substantial access to China’s growing luxury-goods market, such as Switzerland-based watch manufacturer Swatch Group Ltd. and France-based fashion house Louis Vuitton Moêt Hennessy.
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