After a difficult year for stocks in 2018, investors will be hoping that the Lunar New Year will bring brighter prospects for the Chinese stockmarket. The New Year might typically be a time for optimism, but there remains a huge amount of uncertainty about the outlook for China.
The country’s trade dispute with the US dominates headlines and fears that US tariffs on Chinese products are starting to have a negative impact on the world’s second largest economy are unsettling investors. Recent economic data has been weak – factory activity and exports are slowing – and last year the economy grew at 6.4%, its slowest pace since 1990.
In response, policymakers are expected to introduce stimulus measures to support the economy. These include infrastructure investment and policies to boost lending.
Chinese stocks experienced large falls last year as investors worried that the slowing economy would hurt consumer confidence. Some of the weakest stocks were the highly popular internet companies such as Alibaba and Tencent, which had made phenomenal gains in 2017.
The question for investors is whether the picture is as bleak as the headlines suggest. While the headlines certainly suggest that the economy is losing momentum, there are areas where economic activity remains relatively robust. Retail sales continues to increase, for instance. This is encouraging as Chinese policymakers are trying to shift the country’s economy away from reliance on exports towards consumption and services. This trend appears to be broadly on track, even if domestic demand might be a little weak in areas like autos.
Our view is that the preoccupation with the country’s GDP growth is a distraction from what really matters for investment success. Over the long run, corporate performance drives share prices, not economic growth.
Away from the gloomy macroeconomic news, we are encouraged by what is happening at the micro level. Looking at the performance of Chinese companies, their returns on capital are starting to improve (see chart below).
This is not the story that you read about in the financial news. But this is the factual evidence of what is going on – companies are starting to perform better.
Source; Credit Suisse Holt, January 2019. China refers to China universe in Holt.
As a result of the concerns about the macro environment, however, the valuations of Chinese companies have fallen. This mismatch between corporate performance and valuations attracts us and as contrarian, value-focused investors we have been increasing our investments in China lately.
2019 has got off to a great start with investor risk appetite recovering on hopes that trade talks between the US and China could resolve the dispute between the two nations. There are major issues to be discussed and the chances of reaching a deal before the deadline on March 1 remain uncertain.
However, there has been so much pessimism about the trade war that any progress towards an agreement could provide an enormous boost to investor sentiment. The macroeconomic worries have created some attractive opportunities for selective stockpickers in China today. The last Year of the Pig was in 2007 and the Chinese stockmarket soared then. While it is rare that pigs fly, we are optimistic that investing in China could be very rewarding in 2019.
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