Looking to China economy's 'mild recovery'

Mr Lee says that people should not chase the market. Sometimes, for a market like China, one needs to have a more contrarian approach: Buy when people are fearful and sell when people get greedy.
Mr Lee says that people should not chase the market. Sometimes, for a market like China, one needs to have a more contrarian approach: Buy when people are fearful and sell when people get greedy.ST PHOTO: LAU FOOK KONG

In our monthly series featuring leading financial experts and fund managers, Mr Jack Lee, head of A-share research at Schroder Investment Management, looks at the Chinese equity market.

The Chinese economy "will not see a hard landing but... a mild recovery", says one Chinese equity expert.

Mr Jack Lee, head of A-share research at Schroder Investment Management, told The Sunday Times that he is "cautiously optimistic". A-shares are shares issued by corporations registered in China.

The two major concerns about the market last year - that the yuan was overvalued and could see a "massive devaluation", and the economy was headed for a hard landing - have not come to pass.

The Chinese economy stabilised in the first quarter of this year, with "gross domestic product growth on the upside and property, machinery and retail sales improving".

"All these indicate improving investment sentiment," noted Mr Lee, who joined Schroder in 2012.

"Having said that, I'd still call it a mild recovery. China is no longer so investment-driven; the service sector is picking up and playing a more crucial role in driving the economy.

"Over time, if consumption stays at a certain level and investment continues to be slow, we might expect the importance of the service sector to outweigh the traditional investment portion."

The market is now "more or less in the middle, not too bullish or bearish", said Mr Lee. It is also volatile and a bit of a gamble.

"Some people call it the 'casino market'," he said. "You never know what can happen. A lot of people got burned last year in the crash... I think that could happen again because the risk appetites of Chinese investors are actually quite high.

"People should not chase the market. Sometimes, for markets like this one, you need to be a little more contrarian."

Sales of A-shares are restricted but foreign investors can access the market through exchange-traded funds (ETFs) or mutual funds.

Mr Lee manages the China Equity Alpha Fund, which is available only to accredited investors here.

Q How would the mild recovery affect the equity market?

A First, the equity market sentiment might not immediately reflect the underlying economy. People might be sceptical about the recovery. It is not going to be a hard landing, but whether investors come back to the market depends on whether they are willing to take additional risks.

In China, money tends to flow around between the different asset classes.

At this point, the interest rate level has fallen. If investors think the equity market returns will be higher than credit returns, capital will be reallocated to the equity market.

Right now, the leverage level of the equity market is back to the 2014's, with margin financing around 830 billion yuan (S$168.8 billion), compared with the peak of two trillion yuan.

We are more or less in the middle, not too bullish or bearish... There is room for further risk appetite in the market.

Q Where are the opportunities to make returns in the A-share market?

A China's economy is undergoing a structural shift from being investment-driven to becoming more service- and consumption-oriented.

Some stocks will benefit from the growing affluence and consumption sector-wise - areas like food and beverage, liquors and spirits, and even movie production - but a lot of them are quite expensive when analysed fundamentally.

We are also focusing on the tech sector. In the past, mostly everything produced, sold. But now, as we move towards a more service- and consumption-driven economy, companies have to look at producing higher value-added, differentiated goods and services. They have to distinguish themselves through high technological entry barriers or by delivering goods and services with strong branding. A lot of great companies are technology-driven.

One Hangzhou-based company, for example, is the largest in the surveillance equipment sector globally, in terms of sales. Surveillance equipment is everywhere and, supported by investment in that space, the company has seen phenomenal growth for the last 10 years.

It grew into a big company. To be a great company, it invested a lot in research and development (R&D) and hired thousands of engineers.

China has a supply of cheap engineers - the cost of hiring computer and electronic engineers is one-third that in the United States and Europe. With lower R&D costs, Chinese companies can have a strong tech advantage and higher entry barriers. They can be more globally competitive.

Q How might Singapore investors access opportunities in the restricted A-share market?

A It is generally not possible for individuals here to buy A-shares directly. They can buy ETFs or mutual funds instead.

Trading costs tend to be lower for ETFs but if you look at the most actively traded ETF listed in Hong Kong for China A-shares tracking the A50 Index, it is very much financial sector-concentrated.

If you are bullish on China's economic restructuring as a whole, you can buy actively managed funds with diversified holdings, which can be less risky and more stable.

Everyone wants to buy at the bottom but that is not always possible. If you know the market is close to the bottom, you can split your funds into portions. Buy with one-third first and if it drops another 5 per cent to 10 per cent, you can buy with another one-third.

This kind of averaging strategy works as long as you are not buying at the peak. You also have to be patient, have a relatively longer horizon of one to three years, and wait for the market to heat up again.

Q What are some risks investors should look out for?

A Investors buying funds have to be careful about the timing. If you entered in the middle of last year at the peak, when the Shanghai Composite Index was 5,000, you are probably losing money now.

When people are fearful, that is the time to buy. And when people get greedy, you should sell. It is typical contrarian thinking.

Right now, the market is neither too hot nor too cold. As long as it is not at the extremes, it could be a good time to enter, especially considering that the economy has stabilised. In deciding when to enter, you can look at indicators like the price-to-earnings ratio of the CSI 300 Index, which is about 11 to 12 times now and considered to be in the mid-range, not dangerously overpriced.

When the market is hot, margin financing is also high, compared with the market level, and using leverage to buy stocks increases volatility.

A version of this article appeared in the print edition of The Sunday Times on July 24, 2016, with the headline 'Looking to China economy's 'mild recovery''. Print Edition | Subscribe