For many years, commentators have feared a financial crisis in China. They agonized over a rapid rise in its debt and fault lines in its banking system. They called China’s property market a bubble. They forecast that efforts to rebalance its economy away from an investment binge may lead to disaster.
But China hasn’t collapsed. In fact, it outperformed expectations. China government statistics show gross domestic product (GDP) growing by 6.9 per cent in 2017, above the 6.5 per cent target set by the government. It was the first increase in growth since 2010.
What happened? China’s economy is resilient, said Mr Mark Tan, Senior Director and Head of Greater China Equities at UOB Asset Management (UOBAM).
“Its macro and micro fundamentals are improving. The ranks of middle-class consumers are growing. The economy is rebalancing towards consumption, away from investment. Companies are also enjoying a virtuous cycle of growth with higher producer prices and government-led supply side reforms,” he said.
In recent years, growth in China’s consumer and services sectors has been so strong that sectors linked to the “new economy” now form a larger proportion for the economy, compared to “old economy” sectors like real estate and banks, which investors had worried about.
Based on MSCI data, “new economy”-related sectors like information technology, consumer discretionary and healthcare now form about 53 per cent of the economy, compared to 11.7 per cent at end-2010, Mr Tan said. The “old economy” sectors, meanwhile, take up just about 47 per cent, down from 88.3 per cent in end-2010.
Under President Xi Jinping, China’s government also has the political will and power necessary to enact needed reforms to transform the country, Mr Tan said. Its “One Belt, One Road” initiative to invest in infrastructure projects across the world will also generate downstream benefits for its “old economy” sectors like construction and materials.
Meanwhile, as commodity prices rebounded and global demand picked up in 2017, there are beneficial effects across the “old economy” value chain. Real estate transactions and prices have remained steady and growing.
Virtuous cycle, high savings rates
Mr Tan said a virtuous cycle results from a rebounding producer price index (PPI), which tracks the prices of commodities and goods sold by manufacturers.
“Better industrial profitability means more investments into manufacturing capacity to meet better external demand and improved debt servicing capability. Industrial companies also pay higher wages to workers,” Mr Tan said.
Continued supply side reforms, such as the closure of excess steel and coal capacity amid a crackdown on pollution, will ensure further improvements in the demand-supply balance, he said.
Meanwhile, a high savings rate among Chinese households provides another reason to be optimistic about Chinese consumption.
Based on data from CEIC, Chinese urban households saved 31 per cent of their income in 2016, a figure which has been relatively stable in recent years. Rural household savings rates have come down in 2016, but are still at 42 per cent.
By contrast, US households save 3 per cent, UK households save 7 per cent and Korean households save 15 per cent.
“China’s household savings rate is still high and there is a lot of room for consumption growth, which has so far been mainly driven by rising household incomes,” Mr Tan said.
Industrial, consumer, tech opportunities
In 2018, cyclical sectors in China present opportunities for investors, said Mr Tan. Cement prices, for example, are increasing due to market consolidation and better pricing power by producers.
“With the revival of industrial profits, PPI reflation, and supply-side reforms, the old economy becomes an attractive proposition. Materials stocks, industrials, even banks are looking more attractive,” he said.
As corporate profitability improves in the industrial space, non-performing loans are becoming less significant, hence improving the balance sheets of banks.
Relative to benchmarks, UOBAM prefers investing in financials, materials, consumer, and tech stocks. They include electrical and home appliance makers, as well as tech plays in social media and e-commerce. It is less exposed to defensive sectors like Chinese telecom companies and utilities.
The largest stocks in UOBAM’s United Greater China Fund include well-known names like Tencent Holdings, Alibaba Group, AIA Group, China Construction Bank, and Ping An Insurance.
“I believe the tech boom will last a while. Tech will continue to change our lives,” Mr Tan said.
“Unlike the dotcom bubble in the 1990s, today’s companies have real business models and strong profit growth. Tech is also more readily monetised with the prevalence of smartphones and 3G/4G networks. This translates to consumption and revenue growth.”
In terms of valuations, China’s tech giants like Tencent and Alibaba are still not very expensive relative to their high growth potential, Mr Tan said.
For instance, Tencent, which has relied on its gaming segment to generate profits, is trying to monetise its WeChat platform through digital advertising. It is also setting up an e-commerce business to compete against the dominant player at home, Alibaba.
UOBAM also taps upon local knowledge and expertise in order to invest in China, Mr Tan said.
“When we want to invest in tech companies, we have to understand consumer behaviour and their receptiveness towards certain types of platforms like social media and live video streaming. There are certain peculiarities in the market. We tap on the local knowledge and channels we have, and our mainland Chinese colleagues in the investment team,” he said.
Personally, Mr Tan also likes researching companies where consensus opinions are divided. These companies may present better opportunities, he said.
Ultimately, as China rebalances its economy, its corporate profitability and growth will be sustainable in the long term, Mr Tan said.
“China is in its first year of economic stabilisation and profitability improvement, and across Asia, corporate profitability is similarly turning around,” he said.
“As we see the macro risks subsiding and as corporate earnings improve, China’s historical discount to global markets should continue to narrow.”