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The outlook for Chinese stocks: firm but choppy

The outlook for Chinese stocks: firm but choppy

27-07-2018 | Interview

Investment outlooks for China diverge widely. Bears cite property bubbles, debt problems and the trade war with the US. Bulls point to booming consumption, structural reforms and leading technological innovation. We asked Robeco’s CIO China, Victoria Mio, who has been working in the financial industry for over 25 years, to give us her take on China’s prospects.

  • Victoria  Mio
    Victoria
    Mio
    CIO China, co-Head Asia Pacific Equities, Fund Manager Robeco Chinese Equities

Speed read

  • The Chinese economy is expected to grow by 6.5% over 2018
  • Stock markets will move up, albeit at higher volatility
  • The US-China trade war is a risk factor

What are your expectations for China’s growth?

“The Chinese economy grew by 6.8% over the first quarter of 2018. We expect it to remain strong and show 6.5% growth over the year as a whole. The economy is resilient, as consumer confidence remains strong and is supported by higher income and property prices. Industrial production remains robust. Chinese corporate earnings momentum decelerated in the first quarter of this year, but remained strong at 15.6% year-on-year.”

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What will this mean for equity markets?

“We see China's equity markets moving higher in the second half of 2018, as the risks of a trade war have been priced in. The rebalancing of the economy towards consumption and services is progressing well. This will continue to promote greater efficiency, higher growth and better corporate earnings. China’s strong consumption is supported by increasing numbers of middle class households, new urban citizens and aging people. Industry consolidation should be driven further by the government’s supply-side reforms and the reforms of state-owned enterprises. We also expect that by 2020, over 60% of economic growth will be fueled by innovation and technology.”

“Still, we also expect to see heightened volatility in stocks after the strong rally last year, because of internal and external risk factors. The Chinese government is tightening its monetary policy to rein in credit growth. This has raised some concerns about the potential dampening effect on economic growth. In our view, the Chinese authorities are very much aware of the balance they need to strike between credit growth management and economic growth. The main external risk we see is related to the trade war between the US and China.”

How do you expect the trade frictions between the US and China to play out?

“The political and economic relationship between China and the US has changed dramatically, and any expectation of a quick settlement of the disputes would be unrealistic. I recently talked to several financial leaders, government officials, and think-tank analysts from the United States and China, and I noticed a great polarization in opinions.”

“China is gradually opening up the domestic economy by allowing, among other things, more foreign investment in the financial sector, and is containing debt expansion via increased regulation in areas such as shadow banking and fintech. But I’m not sure if this is sufficient to mend the relationship with the US. The real issue, in my view, is that the consolidation of power by President Xi has changed the perception and approach of the western world towards China. The might of China’s size and power in the world has increased, while its ideology is still quite different from that of the US. The Belt and Road and Made in China 2025 strategies are perceived by the US as China challenging the established world economic and political order.”

What can China do to de-escalate?

“During our meetings, Chinese officials reaffirmed their commitment to stay on the path of liberalization and promoting globalization. China has pledged to support global cooperation and the multilateral trading system, making globalization more open, inclusive, balanced and beneficial to all. China will also widen market access by relaxing foreign shareholding limits in the financial services sector, and the joint venture shareholding requirement for foreign firms in the auto sector.”

“Still, we expect to see a series of dynamic moves back and forth from both sides. The stakes in a trade war are high for both countries, and yet both President Xi and President Trump are likely to maintain a tough stance to further their domestic agendas: Xi to push through tough reforms and Trump to help his party win the mid-term elections. The market will likely focus on the potential winners or losers in the energy, auto and tech hardware spaces. Should the trade war with the US further escalate, we expect the Chinese government to loosen policies somewhat in order to hedge downside risks. This is already happening. On 24 June, for example, the People’s Bank of China cut the reserve requirement ratio by 50 basis points to help small enterprises.”

Speaking of opening up, what role does the MSCI inclusion of A-shares play?

“Chinese A-shares are becoming increasingly important. As the A-share market is opening up to investors and MSCI is including A-shares in its indices this year, we expect a lot of capital to flow into the onshore Chinese market.”

“The A-share market offers broad exposure to China, and is currently still lowly correlated with the offshore Chinese market, and other global equity markets. Because of its early stage of development, it provides significant alpha opportunities.”

“Even though MSCI is only including 5% this year, this is an important step, as we expect it to support the renminbi and improve the A-share market’s investor structure from retail-dominated to a more balanced mix of institutional and retail investors. Furthermore, we expect the inclusion to improve China’s capital market liberalization and regulation. Full inclusion will take five to ten years, depending on progress in market accessibility.”

“Major themes, such as the consumption upgrade due to China’s growing middle class, the focus on high-quality manufacturing, and China’s leadership in technology and innovation, are creating many investment opportunities. The Chinese A-share market is a good place to gain access to them.”

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