China: Still flying in the Year of the Pig?

19/02/2019

After a difficult year in 2018, might the Year of the Pig bring investors in the Chinese stockmarket good fortune? 

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The Chinese New Year might typically be a time for optimism, but there remains acute uncertainty about the outlook for the world’s second-largest economy.

Trade tensions

The country’s simmering trade dispute with the United States has continued to dominate headlines around the world. Indeed, concerns about the impact of escalating tensions on global trade shaped the negative investor sentiment that prevailed in the final months of 2018.

Many investors in Chinese company shares have been particularly unsettled by fears that US import duties on a range of goods have started to damage Chinese producers. 

These worries have been reinforced by weak economic data that indicated a slowdown in factory activity and exports. While the Chinese economy grew at 6.6% last year – a rate that would be enviable for most countries – many commentators have focused on the fact this is the slowest rate of growth since 1990. 

Investor concerns

On top of concerns about trade and exports, many investors grew worried last year that the slowing economy would dent domestic consumption, which has become an increasingly important driver of Chinese growth.

Overall, Chinese company shares – as measured by the performance of the MSCI China Index in US dollars – delivered total returns of -18.8% in 2018, making it one of the world’s worst-performing asset classes.

Many of the highly rated technology companies, such as Alibaba and Tencent, whose shares rose in value tremendously in 2017, fell back sharply last year.

The question for investors is whether the picture is as bleak as the headlines might suggest, and how attractive the long-term prospects for Chinese companies really are.

Fundamental prospects

In my view, the common preoccupation with the country’s rate of economic growth is a distraction from what really matters for investment success.

Over the long run, I believe it is corporate performance which drives share prices, not economic growth. Improving returns on capital are one indicator that Chinese companies are starting to deliver better performance for their shareholders.

There is therefore a mismatch between improving corporate performance and valuations that have been driven down by pessimism about the wider economy. For value-focused investors who are unafraid to take a contrarian view, this set of circumstances has created some attractive long-term opportunities.

Indeed, if sentiment towards the Chinese economy improves – as it did, to an extent, at the start of 2019 on hopes that the US-China trade dispute could be resolved – I believe there is potential for a swift recovery in share prices.

The last Year of the Pig was in 2007, when the Chinese stockmarket soared. It may be rare that pigs fly, but I am optimistic that China, in this Year of the Pig, holds selective opportunities for investors who are willing to go against the grain in pursuit of long-term growth.

Important information 

We are not able to give any financial advice. The views expressed in this document should not be taken as a recommendation, advice or forecast.

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