8th September 2015
Tom Becket, chief investment officer at Psigma gives his view of China’s investment prospects
“I manage to pick my trips to Hong Kong at opportune times. One of my first trips was in October 2007, when the Hang Seng was smashing up through 31,000 and the talk was of ‘new paradigms’ (we reduced our exposure and should have sold the lot). Another timely visit was in 2012 when the region was awash with bearish sentiment and Chinese stocks were close to bottoming; we decided to increase our exposure. Having sold our dedicated positions in China earlier on this year, which on a three month view was premature but then prescient on a six month outlook, I arrived in Hong Kong late a couple of weeks ago hopeful of finding assets in China and Hong Kong, in particular, getting down to levels where we could get excited once again. After the recent ludicrously heavy falls, we believe that we are now there and have started to increase exposure.
“If you believe the Sinophobic western press, which is rabidly bearish on China, you would have expected to have arrived in Hong Kong to find fund managers perched on the window ledge and analysts screaming ‘get out, get the fire brigade out and stay out’ (or the Chinese equivalent). This was not the case. Even allowing for the fact that managers want to sell you their respective funds, so naturally err on the side of optimism, we found that both they and strategists had a refreshingly realistic future prognosis for the ever-evolving Dragon. Far from forecasting an ‘old style’ Chinese boom back to 10% growth rates fuelled by a major infrastructure stimulus, all were instead enthused by China’s new lower but ‘quality over quantity’ approach to economic growth. Certainly China has the opportunity to add targeted fiscal stimulus (infrastructure spending certainly isn’t a thing of the past) when it is needed and still maintains the monetary levers required to help the economy when it needs it, as we saw with yesterday’s interest rate cut and reduction in bank reserves. Clearly this is a different situation to the authorities in the developed world, where they are fast running out of bullets.
“China has undoubtedly made mistakes. The comedic handling of the engineered boom and unintended bust of the Chinese stock market was clearly a lesson to be learned. The rationale behind boosting the ‘wealth effect’ through rising share prices might have had some merit (I’m being kind here, but worth noting that Ben Bernanke followed a similar route) but recent fumbles have shown it was a mistake. Moreover, the decision to allow the Yuan to devalue might well have been further evidence of China ‘growing up’ and pursuing the policies encouraged by the normally-wrong fellows at the IMF, but it was badly timed in my opinion. However, we are not of the view that this is just the start of China’s trashing of its currency and, while recognising there might be further steps lower, we do not believe the Chinese want a significantly cheaper currency. The move, if taken as solely an economic decision, was sensible; China is slowing and rates will be cut vs. the view that the US is stable and rates are (supposedly) going up.
“In total contrast to the reams of overwhelmingly pessimistic commentary that we are subjected to over the Chinese economy, there are some bright spots. The property market has picked up and analysts expect further progression in prices and activity. Social housing continues to be extended, in line with the Government’s five year plans. Consumer spending is persistently growing at a solid pace, reflecting China’s progression to their longed-for higher income status. Wage price appreciation and a tight labour market should keep wage price inflation on track. The weak spots are in industrial growth and manufacturing potency. Both would be considered as surprisingly weak, unless you listened to what China said it was going to do for the last five years, namely shift away from the most basic parts of an economy towards higher end consumption. Of course that is what the bears wanted them to do and now they are doing it they are bearish that they are. It is a case of heads you lose, tails you lose, for the much-despised Middle Kingdom.
“Our greatest excitement comes not at a macro level in China, but rather when we look at specific companies and themes. Regional equities are cheap and do not properly reflect the profit growth potential to come in the rest of the decade. To make it clear, I am not talking about spurious internet stocks trading on the questionable Chinese domestic markets, but high quality Hong Kong stocks and ‘red chips’. In sectors that we like, such as consumer names, healthcare, technology, electrical appliances, water and personal finance, stocks are cheap. We also recognise that the state owned enterprises’ reform programmes could provide winners for patient investors. For the bravest amongst us, you can find some frankly ludicrous valuations in small cap stocks, as long as you have a long view, but many areas for investment linked to China offer limited further downside and significant upside.
“To sum up briefly, we feel that the doom merchants have underestimated the Chinese economic potential, which is not wonderfully strong, but nor as disastrous as most believe and many asset markets discount. If you have a three year view, a rare quality these days, then there is great money to be made in China. Yes, there will be moments when you will temporarily question what you are doing and it might take a while to play out, but by moving far away from the maddening bearish crowd and looking towards China, you could be investing in a contrarian investment opportunity to rival that of Japan in 2012.”