Today, the Chinese slow‐down is the most often quoted reason for holding back, but investors are going to have to get used to the idea that China’s economy has been slowing and will continue to do so, because China’s economy is changing.
Some perspective is worth noting. At its current size, 6 per cent growth in China’s economy adds another Switzerland each year. If we were to assume that China’s GDP grew by 6 per cent this year, 5 per cent next year, 4 per cent the year after (a rate of decline that would certainly cause a stir!) then in five years’ time, in GDP terms, China will have added another India.
So, the slowing growth rate is not the issue, but it is the effect this may have on cash generation, profitability and debt servicing that is important. On which point it is worth noting that as China’s economy broadens and deepens into consumption and services, away from debt‐funded investment, profitability improves.
We have been encouraged to see the operating performance of the Chinese banking sector in recent months as the macro‐economic slowdown has become more apparent, because it is in this sector that the ‘old’ and ‘new’ Chinese economies meet. The debt built up by the old economy sits in the banks, and in order for them to provide a useful function in China’s new economy, they have to manage the legacy and transform into market‐led commercial institutions.
The news flow of on‐going regulation, bad debt recognition and improved market practice has been evident in 2018’s market performance, which showed rising net interest margins, solid cost control, accelerated bad debt write‐downs and shrinking balance sheets as shadow banking activity has reduced. Regulatory change has translated into better‐than‐expected operating performance, which in turn has delivered share price outperformance in four of the last five years, including in 2018.
There are signs too that the technology sector may be beginning to come out of its malaise. Semiconductor stocks in the US have reported an improving outlook which has fed through to the performance of companies such as Taiwan Semiconductor Manufacturing Company and chip design company, Novatek Microelectronics.
Further endorsement to fears about the China slow-down followed Apple’s warning that the China slow‐down was responsible for its sales drop. A closer look reveals a different picture: while volume sales of smartphones fell 10 per cent in the fourth quarter, Apple’s sales fell 20 per cent. This begins to look more like an Apple problem than a China problem. This seems especially so, when we see that local manufacturers Huawei, Oppo and Vivo reported volume growth.
Overall, early indications are of a more optimistic picture, though we are still early in the season for earnings reports and company outlooks for 2019. We do not expect Asian markets to hang around waiting for results to come through but instead to look through and anticipate. The chart below shows the forward price/earnings multiple (P/E) for the MSCI AC Pacific ex Japan index over the last ten years; we can see that even after the bounce in January it still looks cheap compared to its history. 
But perhaps most exciting is the valuation of the fund which is at a deep discount to the market. For a group of companies with a return on capital twice that of the broad market and a history of steady cash profits and growing dividends over years, this valuation discount looks wrong.
In the short term we expect China‐US trade talks to overhang the market as they struggle to reach a deal that will satisfy the hawks on both sides. But we do not expect any of this to change the direction of travel. The Asian region offers structural themes (consumption, life‐style upgrading, rising manufacturing skills) that will continue to develop despite the current trade dispute between the US and China.
However, the capture of these long‐term themes is best done, in our opinion, through investment in companies that have demonstrated a long‐term track record of turning them into superior profitability and delivered dividend growth. If Asian corporations continue to report earnings that meet market expectations, then the prospects for investors look bright. Valuations at these levels augur for attractive shareholder returns in the future, especially so when compared to the rest of the world.
Edmund Harriss is manager of the Guinness Best of China, Guinness Asia Equity Income & Guinness Emerging Market Equity Income funds. All views are his own and should not be taken as investment advice.