Investors and businesses, here and overseas, are closely watching China to see if it can once again pull itself and the West out of a downturn.
Market sentiment regarding China has become noticeably bearish, as the market fears growth in China will continue to slow.
They have been disappointed lately, with a range of Chinese economic indicators reporting on the downside and the country reported to be in its deepest slump since the 2008 global financial crisis.
A range of stimuli from the central government in Beijing also appears to have done little to boost the growth of the world’s second largest economy and its 1.3 billion people.
“But we are already seeing some signs that the growth slow-down is stabilising,” says David Urquhart, Portfolio Manager of the Fidelity Asia Fund, “at around the 7.5-8% GDP rate.
“As GDP growth expectations have been revised down, the price to earnings (P/E) ratio of Chinese companies has also fallen to 8.3x [comparatively cheap versus its five year average of 12.1x and also versus the Australian market on 11.2x]. Yet earning per share (EPS) growth in China is expected to outpace that of Australia in both 2012 and 2013. As a result, Chinese shares that can deliver on current growth expectations are now looking attractive.”
Mr Urquhart notes “China is in the midst of rebalancing its economy, and GDP growth is shifting away from being heavily dependent on export growth and infrastructure spend, and towards domestic consumption. As this process of rebalancing continues growth rates will be lower than they have been over the past decade, but these changes will shift China to a more sustainable growth path.
“The composition of Chinese GDP growth has already begun to shift. In the first half of this year, China’s GDP grew 7.8%, of which (a) investment growth added +3.9%; (b) consumption added +4.5% (so over 57% of GDP growth) while (c) net exports subtracted -0.6%. Only a few years ago growth was fairly evenly split between all three of these factors.
“Since the end of 2009 in the aftermath of the GFC, net exports have not contributed to GDP growth. Weak external demand from the US and Europe has removed this previously strong GDP growth driver.
“This also means that some micro data that was an indicator of growth in the past is now less relevant. For example, if one focuses on electricity generation growth, this has been growing at 1.48% year on year (YoY) in April and 3.25% in May. However while this data is very relevant for growth in manufacturing/exports and infrastructure, it is not so meaningful in measuring consumption growth. So by continuing to focus on this as an indicator of GDP growth could easily make one more bearish about China’s growth prospects than one should be. Consumption related data is now much more important an indicator of Chinese GDP growth.”
Mr Urquhart adds “in addition to rebalancing its economy, in 2011 China faced the challenge of high inflation. This saw the Chinese remove fiscal stimulus (eg infrastructure spend on high speed rail was frozen and restrictions on bank lending were put in place for key industries like cement, steel, real estate etc). In other words, monetary policy was very tight. In 2012, with inflation now under control, we have seen some reversal of this tight monetary policy – RRR reductions, interest rate reductions and some easing in restrictions on bank lending.
“Unlike during the GFC, strong fiscal stimulus is seen as neither necessary nor desirable, particularly as we are starting to see some benefits of policy easing that should come through later this year.”
He suggests the latest HSBC PMI is one of a number of indicators demonstrating signs that China’s growth slow-down could be nearing an end. Other indicators also support this:
- China’s export trade grew 15.3% and 11.3% YoY in May and June after only 4.9% growth in April and shrinking in January 2012
- Industrial production growth has also accelerated from +3.8% YoY growth in Jan and Feb to +10.7% in June
- New loans by large banks doubled in the first half of July versus the first half of June
- Rail and highway investment rose by 34% month-on-month and 28% month-on-month in June versus 7% and 8% in May.
Mr Urquhart says “stable growth (rather than slowing growth) combined with attractive equity market valuations make China an interesting investment proposition.
“Increased confidence that China can deliver GDP growth of better than 7% should see China’s flat equity market performance year to date in 2012, improve substantially. China’s growth concerns have been priced into the market at current valuations of 8.3x p/e and 1.5x book value.”
He notes “in other parts of Asia, we have also seen positive GDP growth surprises and/or positive earnings revisions – in countries like Singapore, the Philippines and Thailand – and have also seen strong equity market performance (each up between 15-24%).”
