Bin Shi: positive on China equities in the Year of the Rat

The Year of the Pig was a strong one for China equities. And Bin Shi, Head of China Equities believe that investors should continue to stay positive as the Year of the Rat comes to reign.

23 Jan 2020

UBS Asset Management wishes you happiness, good health and wealth in the Year of the Rat.

日日财源财意来
年年福禄随春到

Why is the Year of the Rat good for China equities?

For starters, Chinese horoscopes associate the Year of the Rat with success, wealth and surplus – three things all investors can aspire to. For China Equities, I see three reasons to stay positive:

1. Resilient earnings growth

Despite the slowdown in China, I continue to see companies with strong earnings growth. This is especially true for non state-owned, new economy companies.

And the increase in company earnings (for new economy stocks) over the last 4-5 years has driven more than 70% of market performance. 2020 will not be different in that earnings growth (rather than higher PE valuation) will determine market performance.

Returns of new economy driven by solid earnings growth

New China performance breakdown (%)

Source: Factset, Goldman Sachs Research, as of October 2019

2. Supportive policies

While we do not expect the Chinese central government to roll out a large scale stimulus package next year, policies will likely be supportive and targeted.

Reforms of state-owned enterprises (SOEs) can be a potential wild card that could unlock hidden value in many Chinese SOEs. We may see some opportunities in SOEs in 2020.

3. Reasonable valuations

China equities in both A share and offshore markets do not look expensive as we head into the Year of the Rat. In fact, China stock market valuations are amongst the lowest in the Asia region currently.

While we have reasons to be positive, we are cognizant that US-China relations remain uncertain and this rivalry could perhaps run for a longer period of time.

China equities are not expensive

12-month forward P/E ratio over ten years

Source: Factset, MSCI, UBS Asset Management, as of 31 December 2019. Past performance is not indicative of future results.

What is your focus in the Year of the Rat?

Those born in the year of the rat are known to be intelligent and quick thinking.

This year, we will continue to focus on company management with such traits. I can’t emphasize enough on the importance of good management – it differentiates the quality companies from the rest.

Geopolitics was a strong force last year and is likely to remain in the background for a while. This makes focusing on quality companies a priority.

After the strong run-up in China stocks last year, we expect performance of good and bad companies to diverge. If you’ve invested based on hearsay and short-term expectations, it would be hard to keep performing well. As the cycle wears on and as growth slows, companies without strong fundamentals are likely to be sold down.

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Is there a secret bait to attracting wealth this year?

Secret baits? Baits for rats may not be difficult to lay. But to build wealth, it’s hard to rely on secret baits or formulae. The UBS-AM China equities team has been successful and I think this comes down to three elements:

1) Clear investment philosophy

Our investment philosophy gives us a framework to think about the companies we want to own. For us, owning good, high-quality franchises is important. This means companies with strong management, companies that invest for the future even if they are already doing well.

We are also high-conviction investors. It is better to take meaningful stakes in stocks you understand well than to spread out your bets out too thinly.

2) Robust process

Having the right investment philosophy may point us to the right path but it may not get us the portfolio of stocks we need. This is where a well-developed process comes in. The team needs to be able to execute the ideas – be it trade orders or following portfolio guidelines.

3) Strong team

Needless to say, we need a strong, cohesive team to put our philosophy and process to work.

We trade in the secondary stock market and there’s no monopoly on the stocks we own. Everything we have, anybody can own them too. The difference (with our peers) comes down to getting the three elements right to the T.

Your flagship China offshore fund is now at USD 10 billion. Has it become too big to manage?

Yes clients might worry about capacity. But opportunities continue to present themselves. China's equity markets and economy are growing rapidly and we see exciting new sectors emerging constantly.

And yes, this elephant can still dance!

Our onshore fund is not the only way to tap into China’s growth. We introduced our All China equity solution to help investors capture high-growth segments be it in the onshore or domestic A share market.

Bin Shi

Head of China Equities


Postscript note on the coronavirus outbreak

The coronavirus is a wildcard and its impact is hard to quantify. Our current base case is that the virus meaningfully impacts Chinese consumption growth in Q1 and then subsequently fades, setting the stage for a sharp rebound. The real impact is more on travel, tourism and consumption related industries but we’d expect this impact to start fading as and when the outbreak has passed its peak. As a comparison, SARS is estimated to have cost the Chinese economy 0.5% points of economic growth in 2003. An expected slowdown in the Chinese economy might have an impact on the more cyclical sectors of energy and materials in EM ex China.

Importantly, the Chinese authorities have the full policy mix at their disposal to mitigate any more protracted negative impact should it prove necessary: further moderate easing through cuts in benchmark interest rates, and on the fiscal side through increasing government spending on infrastructure investment and other high multiplier spending initiatives. Already, we have seen the Chinese government proactively announce a liquidity injection into the Chinese banking system ahead of the market re-opening to shore up financial markets.

It’s still too early for us to draw any formal conclusions to the “catch up correction” we’ve seen with the China market open, but a lot of the initial sharp drawdown is likely a result of Chinese retail investor fear and uncertainty being priced into markets which have been closed over the past week. With full details about the global spread of the virus, its symptoms, incubation period and mortality rates unclear, investors are behaving entirely rationally in the face of uncertainty by selling risk assets and buying safe havens. We cannot say with confidence how or how quickly things are likely to progress. But human tragedy aside, history would suggest that such epidemics have a limited short-term impact on the wider economy that is often followed by a sharp rebound, as pent-up demand is unleashed. We suspect this particular risk will end up an opportunity to accumulate exposure to names we like at more attractive valuations. We continue to monitor the situation and stock prices and are prepared to make portfolio changes at the appropriate price points. There are certain stocks we are keeping an eye on as possible add/buy candidates at the right price points. Overall, we expect this outbreak to have negligible impact on the markets and our portfolios in the medium to long term.

  • This outbreak should accelerate the move from offline to online across a number of business. Hence, companies like Tencent and Alibaba should be long-term beneficiaries.
  • Companies like TAL Education may suffer in their offline (physical classrooms) business in the short term but should benefit in their online business longer term – TAL’s online revenues have been growing fast off a small base, and they are much better positioned than their competitors in this segment – their market share gain should hence get accelerated.
  • Domestic liquor companies like Kweichow Moutai (Moutai) might also be impacted in the short term but this will be mitigated by a few factors: the premiumization trend remains intact, people are still willing to buy ultra-premium liquor at lower prices, liquor has much longer storage life than most other food & beverage items, and Moutai’s sales are to distributors who might take this opportunity to top up on inventory.
  • In healthcare as well, while there may be negative short term impact as the outbreak can potentially reduce patient flow since hospitals are high-risk locations for infection, some companies stand to benefit directly from supplying medicines (e.g. anti-viral drugs) and supplies to deal with the virus.

References to securities are not buy or sell recommendations.


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