Emerging markets | China Time to turn positive on China equities?

Bin Shi, our Head of China equities, explained at webinar that he sees a turning point in both the Chinese government policy and the outlook for China’s equity markets.

08 Nov 2018

We expect that economic fundamentals will bottom early next year and that the impacts of both recent and forthcoming policy changes will be felt soon after, with a likely improvement in sentiment and an upturn in the Chinese equity market.

We have also collated his views in the Q&A below.

You have recently changed your views on the China equity market, why?

We took a very cautious view on the market in the first three quarters of 2018, mainly because of the government's tough deleveraging and regulatory policies, as well as the US/China trade dispute.

But looking at a series of recent policy statements and news announcements, we believe there has been a significant change in the Chinese government's attitude which means both targeted support for the economy and the possibility of a compromise on US/China trade issues.

Can you explain your point on the likelihood of a compromise on US/China trade issues?

Restrictions on overseas investors' ability to invest in key industries, like autos and finance, have been a major sticking point in the US/China trade dispute.

However, we have seen a number of recent cases where the Chinese government has approved a series of major investments in China by overseas auto and financial services companies. These cases tell us that the Chinese government is moving to address the root cause of the trade disputes.

Given the clear signs that the Chinese government is working to allay concerns on the US side, there's a stronger likelihood of a compromise.

And looking at recent agreements with Canada and Mexico, it's clear the US is amenable to trade dispute solutions.

Furthermore, trade wars are harmful for both sides, and recent adjustments in US equities tell us that concerns are growing in the US about the effects of the trade war, which we think will ultimately put pressure on the government to act.

For further visibility on the path of the trade dispute, the tone coming from the meeting between Presidents Trump and Xi Jinping at the coming G20 gathering in November will be key, particularly because the US mid-term elections will have passed by then.

Can you give any more details about how the Chinese government's policy attitude has changed?

President Xi Jinping, Premier Li Keqiang, as well as senior leaders in the Ministry of Finance, People's Bank of China, and China Banking and Regulatory Commission have all recently stated that the government will offer targeted policy assistance for private enterprises in the coming months and will take steps to support capital markets and business confidence.

This amounts to a 180-degree change in the government's policy direction. As this is a unified policy stance across all major government departments, we think it is highly significant because it means there will be a series of follow-through policies to come.

And we are already seeing evidence of policy support already being applied in China. For example, the government has cut social security taxes previously imposed on the private sector, as well as reducing value-added and private equity taxes.

You said that policy has changed but when do you expect we will see the effects?

Investor sentiment is the key issue here and we believe it will take time to rebuild confidence in the market.

Importantly, policy turning points are usually ahead of changes in the market because it takes time for policy changes to have a noticeable effect on the economy.

We expect that economic fundamentals will bottom early next year and that the impacts of both recent and forthcoming policy changes will be felt soon after, with a likely improvement in sentiment and an upturn in the Chinese equity market.

Policy has changed but what about market valuations, how do you see the market now?

Current valuation levels are low compared to both historical trends and to markets across Asia.

10 Years' History: 12M Forward P/E Ratio

Looking back a little, how does the sell-off seen in 2018 differ from that seen in 2015?

The situation in 2015 was completely different. Margin financing grew markedly in the years leading up to the 2015 sell-off. In 2015, the government cracked down on margin financing and dramatically reduced market liquidity, thus causing a prolonged sell-off.

What we have seen in 2018 has been different. Structural issues, like the build-up of debt and the government's strict approach to tackling it through deleveraging policies, have hit the markets, and the trade dispute with the US compounded the situation.

Now you are more positive about the market, what's your view on prospects for A- and H-shares?

In the short-term, the outlook for A-shares may be more positive since the specific policies announced by the government are intended to support that particular market.

Looking longer term, the macro background of the A- and H-share markets are basically the same, so it's likely that valuations will converge over time.

That said, we believe that the differentiation between the two markets will become less important over time. We are focused in looking for opportunities in either market that are best set to benefit from China's growth over the long term. 

12month forward P/E

Looking now at particular sectors, what's your view on financials?

Prospects for the financial sector have improved now that the government has turned more supportive to the economy, which we feel has reduced risks to the financial system.

Currently, valuations for the banking and insurance sector are low and we have added selectively by investing in names that we think have the best prospects.

We have to be selective and focused on financial companies we feel have the ability to be competitive in the long-run because the financial sector still faces risks from non-performing loans and the growth of internet finance.

Have you changed your position on China's education sector?

Government regulations have impacted the whole of China's after-school education industry and that's affected expectations about future growth and valuations. That said, we remain positive on both the sector and leading names within it. Specifically, we think the larger names in the sector have both the resources and the operational ability to adjust to the new policy environment, while it may be difficult for smaller names to adjust.

As such, we expect smaller players will be forced out as the new regulations kick in. This means that the larger companies in the sector will ultimately be able to increase their market share, which is positive for their future. After all, fundamental industry drivers, like urbanization and rising incomes, are still growing strongly.

How will you change your investment strategy given the change in policy direction?

We will likely be more offensive in our equity allocations and put cash to work in the near future.

During the first half of 2018, our cash levels were around 20% because of weaker sentiment and heightened volatility in the market but our levels are now at 16%.

We will, however, remain disciplined in our investment approach and maintain our focus on companies that we believe will deliver growth over the long-term. We continue to be positive on 'new economy' companies in sectors like consumer, IT, and healthcare. We'll most likely add to sectors highly impacted by government regulations, like online gaming and education, because we expect some of these regulations to be reversed in the future.

In summary, we think that investors should have reason to be more optimistic on Chinese equities and, since we see an improving outlook for the market, we believe investors should take action now.

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