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China’s equity market outlook and structural opportunities for investors
Siguo Chen, Portfolio Manager, RBC Asian Equity, shares her thoughts on China's economy, the outlook for its equity market and structural opportunities for investors.
How do you see the economy in China right now?
If we break down the economy by different segments, and they are actually demonstrating different trends. For property, which is a very important pillar of the economy, we're actually seeing stabilizing, but still weak trends.
The silver lining, I could say, is that now, we're more confident that the policymaker will have something in hand, the more expansive policies to help boost the momentum in this segment. That's property.
Consumption is another important segment for the economy. We are seeing weak trends in consumption and even some signs of deflation, but we're actually seeing evolving trends since the reopen from COVID. For example, when it just reopened, we are seeing overwhelming, all segments are basically booming from the pent-up demand.
Afterwards, we're seeing divergent trends, for example, the high-end and the very low-end are doing well, but the mid-segments are actually muted. Then a bit, half a year after that, we're seeing the luxury segments are actually tapering off. One thing very interesting is that now the low-end throughout time has been resilient, and we're seeing the experience type of consumption has held up pretty well.
Other segments like export, well, export has been holding up very well. January and February, we're looking at 7% growth. I think for the overall 2024, we will be seeing a bit around 3% to 4%1 export growth, which is decent. One thing that's still very resilient in the economy is manufacturing.
That's what the policy support will be with as well, which is a segment that we have a bit more long-term confidence in and more comfort in investing in.
What is your outlook for China’s equity market?
For one, the fundamentals are actually not bad, not as bad as some people feel. For example, the earnings growth this year, we're looking at 14% to 15% for MSCI China,2 albeit off a low base from last year. Nonetheless, it is a very strong recovering trend. That's the fundamentals.
We look at valuation, valuations being more than palatable. We're looking at eight to nine times PE which the historical average is 12 times. You cannot make argument of valuation alone, and it's also a bit silly to say that it's in the price. But I think we have seen a big exodus of foreign capital investors outflow from the asset class. Now, with this valuation combined with earnings growth, another very important factor is that similar to other asset class, we are also seeing good investor return efforts by the Chinese companies.
Now we're seeing both SOE and private companies are increasing shareholder return, which is a good thing you want to see in the equity market. I think that's a very good setup for the asset class.
What are the main headwinds for active investors in the region?
The debt issue, the demographic, and now deflation, as well as decoupling, the 4D. The 4D problem that the Chinese economy and markets are facing. Now, this might be a bit unconventional saying or thinking. I think as investors, actually, the macro issues are a bit easier for us to navigate. They are very hard to address as an economy overall, but as investors, because we can pick and choose, it's actually easier to navigate, for example, debt. First off, it's not an issue specific to China. Many major economies now are facing that high debt issue. China is more so with the local government debt, but we believe that there won't be a spillover effect. We just need to avoid certain sectors that have large exposure to that, certain regional banks, certain property sectors, so that's very easy. For demographics, again, it's a bit of a ubiquitous issue with the Northeast Asian countries overall.
As investors, we can play with that trend instead of playing against the trend. For example, we can invest in hospitals or certain healthcare companies that will benefit from that trend. That, I would say, is also easier for investors to navigate. The same, I would say, is with deflation. We have very good company choices with our thematic of trade down. For example, certain companies that provides very good value money, and then their result has been great for the past few quarters and year.
Those are very good investment options for us. I would say the decoupling or geographic issues are a bit hard to navigate for investors. Even that, I think we just need to be disciplined and stay out of the murky territory.
Are there exciting structural opportunities in the China equity space?
I would think of it now, plain, and simple, in two. One is top-down. I know there's been quite a bit of pessimism over China, over China's economy, China's political situation, and market.
Do not ignore the fact that it is still the second-largest economy growing at a decent pace. If we look at equity investment, we have over 6,000 companies you can invest in, which is just the second largest compared to next to the US. That provides you a lot of options to choose from. Let alone that we're also looking at the diversification benefit from investing, let's say, China as opposed to the DM, right? That's a top-down angle. The bottom-up angle, I would just tell you, there are many companies that we see that are growing 20% to 30%3 year-on-year for the next two, three years. With very strong balance sheet, very strong free cash flow, and ROE at around 20%, and only trading at 20 times or even below.
1 RBC BlueBay Asset Management as at July 2024
2 RBC BlueBay Asset Management as at July 2024
3 RBC BlueBay Asset Management as at July 2024
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