The slowdown in Chinese economic growth, exacerbated by the tariffs imposed by the US, and its negative effect on the earnings of companies around the globe, has received significant attention recently. Nonetheless, we believe that an allocation to Chinese stocks remains a highly attractive opportunity for long-term investors who are comfortable with volatility.
Chinese economic growth is slowing—the official Chinese GDP figure moderated to 6.4% in the fourth quarter of 2018. And we will almost certainly see further deceleration in growth in the first quarter of this year. But policy supports are gradually ramping up—monetary policies have been relaxed, infrastructure spending has picked up, and a broad cut to individual income taxes, as well as VATs (value added taxes) and SME (small and medium-sized enterprises) taxes, totaling between 1.0%–1.5% of GDP is expected in March. While there hasn’t been the “bazooka” stimulus package we’ve seen in the past, these policies are helping the economy. We expect headline economic growth to stabilize by the summer. The market agrees—2019 GDP consensus currently stands at 6.2%.
A Meltdown or Company-Specific Issues?
What about the dire warnings coming out of western industrial and tech companies? It’s interesting to note that while Caterpillar warned that “sales of excavators will be flat year over year in China,” its leading Chinese competitor, Sany Heavy Industry, expects double-digit growth in excavators this year. In fact, in a regulatory filing last Friday, Sany Heavy reported that 2018 profits were up roughly 200% year over year. What’s caused this disparity? The difference comes down to market share—Chinese industrial companies continue to take share from global competitors.
Fears about a weakening Chinese consumer are also widespread. The weakness seen in Apple’s iPhones and the entire smartphone supply chain, is real. That is because the hyper-competitive Chinese smartphone market is now saturated. Even Chinese smartphone makers are suffering from the slowdown. But it’s not all bad news from Chinese consumers. Global consumer companies, from luxury goods, like Tiffany & Co., to staples companies, like Proctor & Gamble, reported seeing no “signs of a slowdown in the country.” Some domestic consumer names, such as sportswear brand Li-Ning, are also experiencing strong business trends.
With all these uncertainties, it’s remarkable that the Chinese market is up in 2019! The offshore MSCI China Index (USD terms) and the MSCI China A Index are both up around 8% so far this year*. Part of the reason, we believe, is that investors are taking advantage of last year’s dramatic decline in Chinese shares, with much of the bad news already embedded in share prices. Indeed, the Chinese indices are trading at a cheap valuation—approximately 10x 2019 expected earnings—that we haven’t seen for quite some time.
*YTD through January 28, 2019
- John Lin
- Portfolio Manager—China Equities