Chinese Year of the Rat: more about spending than saving?, January 2020

Quite fittingly – because pigs are symbols of wealth and prosperity - the Chinese Year of the Earth Pig was a pretty good one for investors in the country’s stock market. From 5 February 2019 to 24 January 2020, the MSCI China A index returned 22.1%*, the MSCI China index rose 9.1%* and the average China equity fund returned 15.3%*. Not a bad result considering the continued slowdown in its economy and the ongoing trade wars with the US.

But what will the new year of the Metal Rat, which started on 25 January 2020, hold in store? Here, a number of Chinese equity managers give their views:

Darius McDermott, investment advisor to the VT Chelsea Managed Funds range

“While the Chinese economy has been slowing for some years, the slowdown has been managed and the growth rate is still the envy of the rest of the world. China also has the largest population and, importantly, this population has a growing middle class.

“We have seen phase one of the growing middle classes - the purchasing of white goods such as washing machines and cars, etc - and now we are starting to see phase two, where consumers are upgrading to more expensive models. This means that consumer spending is increasing, which is good for companies and therefore investments. As a long term story, the Chinese consumer should be an attractive one for investors.”

“It's not all plain sailing though. Chinese demographics are not great – it has an aging population that is feeling the consequences of many years of a one child policy. Debt is also very high - for the government, companies and now individuals. The banking sector is one that many professional investors avoid as a consequence.”

Nicholas Yeo, head of Chinese equities at Aberdeen Standard Investments agrees that the consumer has potential:

“In the Chinese zodiac, rats can be characterised as cautious savers. However, there is a structural economic reason to believe that Year of the Rat will more about spending than saving, both by Chinese consumers and potentially the government.

“Increasingly wealthy Chinese – in particular, a fast-growing band of middle-class millennials who earn and spend more than their parents ever did – are driving domestic consumption.

“For example, it is estimated that Chinese tourists will make 160 million outbound trips from the country in 2020. That’s equivalent to the entire Russian population on the move. Add in domestic travel and the figure rises closer to 500 million. That promises to have knock-on benefits for segments such as airport operators and duty-free shops.

“Rising levels of wealth have also set in train a premiumisation trend in China, with premium brands enjoying faster growth than lower-end peers. Moreover, rising disposable incomes are spurring demand for health-care products as well as wealth management services and insurance.

“We might also see more policy action from the government. Last year officials loosened restrictions on residency rights in all but the largest cities and promoted public services for all permanent residents.
“This should make it easier for migrant workers and their families to relocate, driving up China’s urbanisation ratio and supporting consumption. People gravitate to cities to find better jobs, health and education services.

“We may see the government speed up its pace of reform this year by prioritising fiscal stimulus. It is already developing urban centres, such as the Greater Bay area linking cities in southern China. It could accelerate this process, on the understanding that the best insurance against global uncertainties is to bolster the domestic economy.

“Ultimately we’re confident it will be spending, not saving, that will define Year of the Rat. Beady-eyed investors with a nose for an opportunity should be able to take advantage.”

Hyomi Jie, manager of Fidelity China Consumer fund, naturally also likes the opportunities investing in ‘how and what China consumes’:

“It is clear that China’s economy remains under pressure amid a general global slowdown, headwinds from the trade conflict with the US and a more prudent approach to fixed asset investment. However, as we enter 2020, I think we may see signs of recovery. The government is carefully easing its monetary and fiscal stance, as evidenced by rate cuts and tax cuts.

“As yet, the impact on markets given increased political turmoil has been muted. However, some of the underlying concerns driving political discontent - such as increasing wealth disparity and conflicts amongst generations - are more likely to become a focus of economic policy in many countries. This in turn could weaken overall confidence in the economic system and markets.

“I continue to believe that the opportunity to invest in how and what China consumes is significant and continues to impact a broad range of companies beyond traditional consumer sectors. What’s more, this theme - powered by the twin drivers of urbanisation and a rising middle class - still offers a long runway of growth.

“The rise of the middle class and increasing urbanisation, and the structural consumer trends this brings, remains the core thrust of our opportunity set and where I believe we will see the greatest opportunities in 2020.”

May Ling Wee and Charlie Awdry, managers of Janus Henderson China Opportunities, offer a word of caution:

“There is ultimately no easy resolution to the strategic rivalry between the US and China. Re-escalation of the trade and technology wars can happen at any time. As investors, this is a difficult issue to navigate, especially when the US has many non-trade levers to pull. The trade war not only hurts China and the US, but also the global economy, as well as portfolio inflows into Chinese investments.

“Smaller regional banks in China continue to face liquidity challenges especially in the aftermath of three regional bank defaults this year; the implicit guarantee of previous bailouts has been removed. While China’s large banks are relatively well capitalised, there is a possibility that they can be called upon to rescue failed smaller regional banks.

“While it is likely that China’s growth will slow in early 2020, the expectation is for the government to step up both fiscal and monetary easing to stabilise growth. Rate cuts (to lower borrowing costs) have been put in place, but have yet to translate into an increase in the volume of credit. If credit volumes return, infrastructure investments rise, and business confidence strengthens, we could see a possible near-term cyclical bottoming in the economy. In our view, this is likely to be a more supportive backdrop for the better value, leading industrial and consumer cyclical companies (that tend to be more sensitive to changes in the economy) in China.”

Jasmine Kang, co-manager of Comgest Growth China, concludes:

“The shift in the Chinese economy from credit and infrastructure-driven growth to innovation, services and consumer-oriented growth is almost complete and real incomes are growing steadily. The opening of the Shenzhen and Shanghai stock markets is proceeding at a rapid pace and China’s long-term potential as a financial centre is huge. The improvement of transparency and environmental, social and governance issues is still in its infancy, but more companies are already reporting in accordance with international standards.

“Despite the positive changes in the general environment, China remains a challenging place for stock picking. In China it is particularly important for minority shareholders to be in the same boat as the company's decision-makers and managers. Investors should have a diligent rat-like squint at potential investments to see if their growth is underpinned by strong and open governance structures.”

*Source: FE Analytics, total returns in sterling, 5 February 2019 to 24 January 2020.

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the individuals and do not constitute financial advice.

Published on 27/01/2020

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