China, 2016 was a turnaround year, opportunities in the equity market

The Chinese consumption story is too often overlooked or even worse: misunderstood and missed by most active managers and clearly underrepresented in passive vehicles.

China’s consumption story is expanding quickly and the large pool of A-shares is where to find many of the most appealing investment cases. Urbanization is one of the key drivers of the economic transformation away from heavy industry dominated by State Owned Enterprises (SOEs) to a private sector-led economy driven by domestic consumption, tourism and services.

People often and rightly believe that investing in the stock market requires professional knowledge and experience. It is apparent that to be a long-term winner in China needs local knowledge and experience. The Chinese market is indeed volatile and full of uncertainty but never short of investment opportunities.

Even though macroeconomic conditions are weaker than in the past, a hard landing is unlikely. After all, the current situation is a result of a raft of economic reforms, and should not be interpreted as any fundamental slowdown in activity. In the past, secondary industries, especially the real estate sector, were the drivers of domestic growth. Now the reform agenda is meant to enhance the contribution from tertiary industries. As a result, it could deliver a more balanced, inclusive and sustainable development. Within those reforms, the “new economy” investment cases are emerging as key investment targets for long-term investors. Among others, compelling investment ideas are emerging from national defence, aerospace, new-energy automobile, medical services, information, intelligence concepts and TMT (technology, media and telecom). Essentially, those are the sectors highlighted in the 12th and 13th five-year plans. Even though some of these concepts are quite mature in Western countries, this is not yet the case in China.

There is an expectation that Chinese equity markets could be volatile in the short run but will gradually resume a normal trend thanks to the winners in the new economy. The lack of confidence amongst market participants on state-owned sectors makes the overall investment sentiment much more short-term. It is better to avoid those volatile sectors with a good example being state-owned banks. Thematic and consumption-led investment cases should dominate positive market movements. As for liquidity, with the mission to complete supply reform in the near future, the Chinese government is unlikely to release a series of monetary or fiscal stimulus polices, but rather maintain a moderate level with open-market operations.

This is as a positive environment for the market to regain stability. In the long term, while real estate prices seem set to remain high and bond yields to decrease, equities, especially the undervalued ones in the fast-growing sectors, will continue to offer greater asset allocation advantages than other assets. “New stories” emerging from a growing consumption-led economy will remain the alpha drivers in the markets.

2016 shows evidence of a turnaround year not only for the Chinese economy but also for financial market deregulation and Chinese equities. A-shares provide investors with diversification in their Chinese allocation but also access to a larger pool of investment opportunities. Many of them are closely linked to the economic transformation of China. China’s consumption story will continue to develop and provide experienced managers with market inefficiencies to exploit.

Peng Yao – Fund Manager, Asian Equities – Union Bancaire Privée