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China keeps chugging along

Eric Moffett, portfolio manager of the T. Rowe Price Asian Opportunities Equity fund, looks at the case for investment in China and where new investment opportunities might arise.

Eric Moffett

By Eric Moffett, T. Rowe Price
Tuesday June 13, 2017

You rarely hear positive press about China; it always seems to focus on one ‘crisis’ after another. The recent months have followed the same old story. China was expected to be hit by the US raising rates, alongside trade wars and other rhetoric from Donald Trump. However, China has kept chugging along.

Recent government infrastructure spending has been very supportive of growth, with first quarter GDP coming in better than expected at 6.9 per cent. In other positives, incomes are continuing to grow and the currency is stable, at least for now. There are actually areas of the economy that are doing great – for example, insurance premiums are up 25 per cent a year and travel spending is 30 per cent higher. While China still carries too much debt and has other structural issues, the economy is currently stable. The market is now beginning to realise this.

Why the congress is the major focus for 2017

The key event to watch this year is the upcoming change of the standing committee of the National People's Congress. This will consolidate the power of president Xi Jinping. There is a need to ensure the economy continues its positive momentum until this point and the recent stimulus has seen to this. The question is what comes after he consolidates his power? Xi has been clear he wants to push through supply-side reform, remove excess capacity and clear up the financial system. Some commentators are dismissing this as just rhetoric, but he said the same thing about removing corruption a few years ago and he made good on his word.

As an investor, if Xi can address supply-side reform, it will be positive for China's terminal value, but negative for growth. What it means for markets is the next question. Over the long term, it will be positive for the Chinese economy and will throw up interesting opportunities.

If Xi can push through reforms of state-owned enterprises (SOEs) and inject managers more focused on delivering shareholder value, many of the companies regularly dismissed by external investors will come back into focus. The authorities are already trialling reforms, with China Unicom one company which has benefited from a more market-oriented management team. This could be a catalyst for more reform.

Regardless, we are finally witnessing management discipline in China, with businesses now throwing off a lot of free cash flow after significantly cutting unnecessary capex. It is a complete reversal of what we witnessed five or so years ago and we believe it is still underappreciated by the market.

Bright spots in insurance, cautious on banks

While the banks are reporting strong earnings for the first time in a while, we believe it remains an area of the market to be cautious on. It is tough enough getting clarity on the loan book of a US or UK bank, let alone one in China. In our view there are enough opportunities to demonstrate our bullish view on China without making a bet on an opaque area.

Insurers are different, as we believe there is tremendous scope for this sector to grow in Asia. This is why AIA remains one of our top holdings. AIA has benefited from increased cross selling of financial products and has recently been given licences to operate in more cities. While it is well owned, we believe it is a high quality compounder, with strong earnings continuing to come through.

Performance of FTSE China A 600 Financial Services over 1yr

Source: FE Analytics

China property has also been performing well, as incomes are growing and there has not been a lot of new supply. While prices are rising, affordability remains fine. There has been a considerable slowing of apartment building over the last few years, which means inventories are now quite low. We believe there is room for construction to pick up. Property, which is a huge engine of the Chinese economy, has effectively been switched off over the past few years. Shanghai and Beijing are certainly expensive, but affordability is ok outside of these markets. Property group China Vanke is one of our holdings in this space.

Eric Moffett is portfolio manager of the T. Rowe Price Asian Opportunities Equity fund. The views expressed above are his own and should not be taken as investment advice.

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Data provided by FE. Care has been taken to ensure that the information is correct, but FE neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.

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