Outlook 2019 - China: Down but not out

  • 25 Dec 2018

    Chinese consumption-led opportunities should benefit from the ongoing structural shifts that will play out over the next few years, even as short-term concerns unnerve investors.

    1. Short-term risks from the trade war and deleveraging impact remain

    2. Chinese consumption-led opportunities should benefit from the ongoing structural shifts over the next few years

    3. Companies with a high return profile and strong execution capability can deliver returns

    1. What is your investment outlook for Asian equities in 2019?

    After two years of encouraging GDP growth, natural and cyclical adjustments have subdued Chinese economic activity in 2018. A high base impact and inventory build-up, as well as the effect of deleveraging, has also dampened the pace of growth. The Sino-US trade dispute has also weighed on sentiment and continues to unnerve investors.

    We are also seeing subdued levels of consumer confidence, as slower economic activity is prompting concerns about the potential impact on income growth as well. Against such a backdrop, it would be realistic to expect a downward revision to corporate earnings growth estimates in this operating environment.

    Encouragingly, Chinese policymakers have reiterated their pro-growth stance during the year through fiscal measures to support domestic demand. Once the impact of policy support filters through, and corporate earnings expectations are reset to realistic levels, the elements for a cyclical recovery in the Chinese economy will be in place. It is also crucial to highlight that the structural growth prospects have remained firmly in place, notwithstanding the short-term issues.

    2. What do you think could most surprise investors next year?

    Uncertainty is the greatest risk to market sentiment at this stage. There is substantial ambiguity around the resolution of the Sino-US trade disputes and possible concessions. My assessment is that over a short time frame, it may be difficult to deliver a win-win resolution to this dispute, and I will continue to maintain a cautious stance.

    However, I am monitoring the situation closely and will reassess my outlook accordingly should the situation take a positive turn. I am also mindful of the cyclical pressures imposed by Chinese deleveraging. While the consensus view is that Chinese policymakers will adopt a flexible stance to offset weakness in domestic economic activity, and it has several tools at its disposal to propel growth, it would be a negative surprise for investors if the policy response proves to be inadequate.

    While trade-war oriented concerns could prevail for the next few months, and there are some cyclical headwinds from deleveraging in the short term, from a long-term perspective, Chinese consumption-led opportunities should benefit from the ongoing structural shifts that will play out over the next few years.

    As income levels continue to trend upwards, Chinese consumers are likely to upgrade their demand for a better and wider range of products and services. The ongoing integration of technology into consumer behaviour, and product and service delivery, is also structurally altering the consumption paradigm in China.

    3. How do you plan to capture the best opportunities?

    I favour companies with a high return profile and strong execution capability. As mentioned above, my emphasis is on companies that can maintain brand equity and pricing power, and deliver volume growth in this backdrop.

    Given that China is a regulation-driven market and regulatory shifts can be unpredictable, I also prefer companies and management teams that have the dexterity to respond better to regulatory uncertainty versus their peers, which can help to provide some relative downside protection.

    The sharp selloff in Chinese stocks over 2018 has presented attractively-valued opportunities in bellwether companies that are leaders in innovation and have embedded their products and services into our daily lives. I also prefer selected insurers that are well placed to benefit from the structural growth in protection-based products, as well as proactive technology adoption. Their incentive structures and well-established agent networks place them well to grow new business.

    Among consumption-oriented ideas, I prefer businesses that are catering to consumption upgrade demands, leveraging both technology-led mechanisms and substantial nationwide distribution networks. In the prevailing risk-off backdrop, I am also favourably inclined towards companies with defensive business models that are trading at trough valuations.