Don't write off China, Evergrande is no Lehman: DBS CIO

CONTAGION fears from the Evergrande crisis and Beijing's continued regulatory crackdown across sectors have left many investors throwing in the towel on China.

But do not be quick to write off China, said DBS chief investment officer Hou Wey Fook, noting that a 30 to 40 per cent fall in the Chinese stock market every few years is "not uncommon", as seen during the height of the US-China trade spat or when regulators tighten financing measures.

"Very quickly afterwards, the market recovered and went back to new highs. Chinese long-term fundamentals have not changed. We continue to see some 6 per cent annual growth going forward," Mr Hou told media at the bank's fourth-quarter market outlook on Tuesday.

While troubled property developer Evergrande is a large borrower in China, its potential collapse will be "manageable" and will not trigger contagion across world markets, as compared to the Lehman Brothers crisis in 2008.

China today accounts for only 3 per cent of the global equity market capitalisation and investors are already positioned defensively from the Chinese equity market.

"Unlike the Lehman crisis, I do not see the pervasiveness of highly leveraged structures. Evergrande is also not a financial institution, so systemic counter-party risk of the global financial system will be minimal," said Mr Hou.

BT in your inbox

Start and end each day with the latest news stories and analyses delivered straight to your inbox.

Sign Up

Sign Up

DBS continues to favour large Chinese banks for their 5 to 6 per cent dividend yields, seen as sustainable in the long run given their conservative payout ratio of 30 per cent versus more than 50 per cent at regional or global banks.

Mr Hou added that the bank also favours the A-share market comprising traditional companies that will ultimately ride on the long-term positive fundamentals of the economy.

Addressing concerns over real estate woes on Chinese banks' asset quality, DBS strategist Yeang Cheng Ling noted that the banking sector only has a 6.6 per cent exposure to real estate development loans.

The sector also has a loan loss provision of between 180 and 190 per cent; this rises to above 200 per cent for the larger banks, he said.

In recent months, Beijing's sweeping regulatory curbs have sent global markets reeling. In particular, the government's approach to move away from "too high a dependency on behemoth institutions" has triggered a massive sell-off in Chinese tech and Internet companies in the order of 40 to 50 per cent, said Mr Hou.

While it does appear "very tempting" to bottom-fish at these bargain levels, the bank is awaiting more clarity on the regulatory roadmap before adding positions in Chinese Internet and tech stocks, notwithstanding their attractive valuations today.

Overall, China's approach to create more inclusive growth will lead to a more sustainable and longer-term growth trajectory, said Mr Hou.

Investors should not lose sleep over how long the regulatory pain will last but instead look towards a stronger market in the long run.

"With policies being introduced in such a transparent way, investors will see a clearer picture of how companies are operating and how the sectors are being governed," said Mr Yeang.

On a global scale, the Fed's looming intent to taper its quantitative easing (QE) policy have stoked fears of a taper tantrum that would derail the 18-month uptrend in risk assets of equities and high-yield bonds.

Mr Hou noted that panic had ensued in the 2013 QE taper, leading to heightened market volatility. "But this time around, we believe the Fed will be very deliberate in communicating their intent and roadmap, and financial markets will be on stronger footing amid a continued zero-bound rate policy stance."

In terms of DBS's asset allocation strategy, equities take up half the portfolio with a preference for developed markets amid the onset of a Fed taper. Notably, US equities account for 27 per cent.

Some 30 per cent are parked in bonds. DBS had initially favoured high-yield over investment-grade in a reflation scenario; it has now turned neutral on high-yield bonds as their fundamentals have not caught up with valuations in the recovery.

But the bank remains positive on Asia credit as current weakness in the region - driven by macro-level debt reforms - is more idiosyncratic than systemic. Credit stresses are more concentrated within specific highly leveraged issuers, mainly in the CCC rating bucket, said Mr Hou.

Excluding distressed credit mainly from Evergrande, the yield level of Asia high-yield bonds stands at around 6.45 per cent, compared to just 3.76 per cent and 2.97 per cent in the US and Europe respectively.

As the world forges ahead into digitalisation, DBS is seeing a spike in capex spending among the world's leading semiconductor equipment makers. Sustained high demand for integrated circuit chips as well as new revenue streams for upstream hardware and software ecosystems can be expected.

Other investment winners of this uptrend in tech capex include artificial intelligence, biotech and medical devices, data analytics and cybersecurity, electric vehicles, and 5G communications, to name a few.