The government in Beijing is dampening the pace of growth and steering the economy onto a reform path to sustainable development. With the rebalancing of the economy pointing to less investment and more consumption, the opportunities for Chinese equities look set to improve over the long term. If the plan succeeds, this will be in keeping with the upcoming Year of the Sheep, traditionally regarded as a year of harmony.
The frequently-criticised low growth rates do not in any way contradict rising stock prices. After all, China is still growing at 7 to 7.5 per cent a year. Average incomes in China have risen eight-fold to $8,000 over the past 15 years and the country may even rise to second place behind the US in terms of consumer spending this year. Both local and international brands can benefit from increasing purchasing power.
Performance of indices over 1yr
Source: FE Analytics
Regulatory change and wider reforms are transforming China’s growth model into a ‘new economy’ driven by consumption and innovation. Technology, health, environmental technology and consumer goods sectors are set to benefit the most over the long term.
These sectors are the main focus of the government’s reform efforts and are set to play an ever increasing role in the Chinese economy in the future. They are also being actively promoted by the state through tax concessions, research budgets and offers of inexpensive land.
Reforms targeting wage increases and the resulting increased consumer spend have been particularly positive for technology firms including internet service businesses, mobile app developers and technology outsourcing firms. With rising standards of living firmly on the agenda the healthcare industry has also see a boost, with increasing demand for senior care, medical insurance and private medical care.
In contrast, many companies in traditional sectors such as industrials or commodities which benefitted greatly from the rapid growth in previous decades are now struggling with structural problems such as higher wages and over-capacity. The main problem in these so called ‘old economy’ sectors is the high debt ratio, with many companies in heavy industries plagued with rising debt burdens.
On the other hand, companies in emerging sectors are structurally sound and have little or no debt as a result of their strong ability to generate earnings and cash.
The structural advantages of the technology, health, environmental technology and consumer goods sectors were overlooked in last year's stock rally. Falling oil prices allowed the Chinese central bank to loosen monetary policy. Due to low interest-rate levels, equities have become even more attractive compared to other investment options.
Chinese households have a very small percentage of their wealth invested in the domestic stock market. Up to now, they have primarily invested their money in savings deposits, gold and real estates.
The recent strength in the domestic stock market has improved local investor sentiment, and lifted companies’ valuations from a very low level. As investor interest in domestic equities grows, companies will be able to issue shares to pay off debt.
In the same fashion, central government and local government could sell their stakes in state owned enterprises, which is a critical step in China’s reform plan. The proceeds from such privatisations could also be used to reduce the indebtedness of local government and improve government finances.
Chinese government policy will be supportive of the local stock market, with an aim to establish a slow and steady bull market in China.
Jian Shi Cortesi is manager of the JB China Evolution fund at Swiss & Global Asset Management. The views expressed above are her own and should not be taken as investment advice.