February 2019
Author: Neil Dwane, Global Strategist at AllianzGI
We expect China may deliver slower growth in the near term because of its high debt levels – estimated at as much as 300% of GDP – and because of concerns about the trade war with the United States. But more important than trade headlines is the potential for a US-China “tech cold war” that could result in two competing high-tech ecosystems and force the rest of the world to choose sides.
As trade tensions drag on, investors should watch for companies around the world – but particularly in the US and China – that are grappling with threats to their manufacturing supply chains. It’s also important to be mindful of export-driven companies that could see weaker earnings growth prospects due to trade-related issues. On the positive side, some companies seem set to benefit from these tensions – particularly in countries such as Vietnam, which is picking up new manufacturing business as the trade war drags on.
High debt levels, slower growth and trade wars are long-term issues that can’t be solved overnight, but we believe China’s government has the right tools to solve them. President Xi Jinping has spelled out clear strategies to create more demand inside China and to move up the value chain of many industries. This is at the heart of the “Made in China 2025” programme for advanced manufacturing. By shifting China’s industrial capabilities into high-tech areas such as aerospace and robotics – and away from apparel, consumer electronics and other lower-value products – China hopes to avoid the “middle-income trap” to which so many emerging economies have succumbed.
In terms of sheer economic growth, China is no longer the force it was for the last 20 years. As it lowers its debt levels and rebalances towards a consumer-driven economy, it will become a different type of investment opportunity. But in the very long term, China is almost certain to become the largest economy in the world – and a global leader with a seat at the table in Asia and elsewhere. So we believe investors must think about how to allocate to China – just as they think about how to allocate to the US.
This is a far cry from today, where most investors’ global equity portfolios allocate a fraction to China versus the US. But if you think about the sheer scale of China's economy, we believe this points to a significant mismatch. As a result, we believe we are at the beginning of a long journey that will see investors consistently increase their allocations to China over time. Of course, this is a new theme to many investors, in large part because China's financial markets have essentially been closed to foreign investors for years. Only recently have we seen an opening up of the access to China's equity and bond markets to foreign investors through the “bond connect” and “stock connect” programmes.
But with greater access comes new risks and opportunities that investors need to navigate. With that in mind, here are some of our top investment ideas for the year ahead:
We know China has its challenges, but we believe its leadership is well-placed to handle them – which helps make China an asset class that clients should consider actively participating in. In the end, it's not really a question of whether investors should buy China – in our view, the better question is rather how much they should buy.
Shannon Zheng, Product Specialist, Asian Equity Team, AllianzGI
According to Chinese astrology, the Year of the Pig, a year of fortune and luck, is a great year to invest. And so far we haven’t been disappointed – 2019 has got off to a prosperous start, especially if we look at China’s stock market. The China A-shares markets have been star performers so far this year. Year to date, MSCI China A Onshore Index has returned 27% (Source: Bloomberg as at 25 February 2019, USD terms).
What we seem to be experiencing here is a change in market psychology. The China A-shares markets are prone to significantly deviate from fundamentals, as they remain dominated by individual investors. In 2018 we witnessed what can happen when investment sentiment in China A-shares becomes overly bearish, and this can present long-term opportunities to active investors.
2019 so far is a different story. Realising stocks were oversold, investors have a definite glint of optimism in their eyes with a view that the market has bottomed out and long-term prospects are strong. Coming into 2019, Chinese government policy turned somewhat away from a focus on deleveraging towards a more supportive stance, and China has loosened both monetary and fiscal policies. In addition, recent news from the China-US negotiations has pointed towards a potential agreement, bringing hope for a de-escalation of the trade war.
As expected, MSCI significantly increased the weighting of China A-shares in its widely followed indices, which will be implemented in three stages this year. In aggregate, the change is expected to result in a potential inflow of around USD 70 billion – not large in the context of Shanghai and Shenzhen daily market turnover, which can be over USD 100 billion, but our view is that China A-shares weighting will continue to increase.
Despite the optimism, economic data in China has continued to be weak and many companies have announced sluggish earnings. Whereas last year these results would have been met with a sharp sell down, however, this year investors are viewing them as already priced in and near the bottom of the earnings cycle, and they are eagerly looking ahead to greener pastures – to later in the year when earnings are expected to show signs of recovery.
As a result, China A-shares had a stonking start to the year. P/B and forward P/E of the MSCI China A-shares Index have recovered closer to, although still below, their 10-year averages. Fundamentals appear to be bottoming and we expect an improvement in momentum of corporate earnings in the coming months.
While the rally has been rapid this year and a period of digestion will be required, we believe that the China A-shares markets continue to offer good value and that the long term rally has only just begun. Our view is that MSCI weightings will continue to increase so that ultimately China overall will account for something in the region of 40-50% of the EM benchmark, with close to half of this in China A-shares.