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Key themes when investing in Chinese equities in 2018
DESPITE the recent market volatilities, we remain constructive over Chinese equities, especially the new economy sectors. We think there are six key investment themes in investing in Chinese equities in 2018.
We like the Chinese IT/e-commerce, banks, healthcare, insurance and consumer staples sectors.
Here are the six key investment themes:
Traditional economy sectors continue to slow
We believe that China's GDP growth in 2018 will be dragged by the slowdown of the traditional sectors such as the debt-reliant areas of infrastructure and real estate.
China's infrastructure investment increased by 15.8 per cent in 2017 and we think some moderation in growth is likely this year.
The government slowed down new project approvals late last year in response to the quick debt build-up. Project pipelines are likely to shrink as infrastructure investment growth decelerates this year.
Real estate investment growth is also likely to ease with the cooling property market. Real estate investment increased by 7 per cent in 2017 overall but had already started to moderate in the second half of the year in response to government tightening measures.
As the government continues to de-leverage the economy, we think property sales will slow down in a higher interest rate environment. We think the government is unlikely to loosen the strict property market rules this year because it will want to continue to be seen as vigilant on speculation.
The construction of rental housing will be a focus this year.
New economy sectors are still key growth drivers
On the other hand, we remain constructive on the new economy sectors (e-commerce, Internet, healthcare, consumption upgrade) as we think they are still on a secular growth path.
Chinese consumers are changing their consumption patterns, shifting part of their purchases from brick-and-mortar stores to online stores. This consumption pattern change is irreversible and ongoing.
Besides, as households' disposable income rises with higher wage growth, there is an obvious trend upgrading the sort of goods (or services) bought. Chinese consumers now prefer higher-quality and more individualised products, and they are spending more on healthcare and insurance.
Further de-leveraging to reduce financial risks
Reducing financial risk remains the top priority this year, and the government will continue to push financial de-leveraging and state-owned enterprise de-leveraging.
China's debt growth moderated recently and credit growth generally improved with rebound in industrial profits. In December 2017, 85 per cent of China's steel companies made profits, compared to December 2015, when only 5 per cent of steel companies made profits.
Corporates have used the higher profits and better free cash flows to fix their balance sheets as industrial companies saw their liability-to-asset ratios decline in 2017.
We believe these positive developments will be supportive of large banks as they will be benefit from the better credit quality of industrial corporates, and they are less likely to be affected by financial de-leveraging and regulatory tightening than smaller institutions.
Higher market interest rate amid financial de-leveraging environment will also support the net interest margin expansion of the large banks, in our view.
In 2018, we believe the tight monetary environment will benefit the industry leaders due to their better access to low-cost funding, especially in the property sector. Industry leaders should gain more market share because of their better pricing power this year, as they are also not likely to be affected by government's environmental inspections to clean up capacity with higher pollution.
Higher CPI, lower PPI
China's consumer price inflation was low at 1.6 per cent in 2017 due to the unusually low food price. But we believe the inflation will rise in 2018, driven by higher food prices, increased wage growth and higher raw material prices. We think higher CPI will benefit consumer staples.
On the other hand, producer price inflation will likely fall back from its high of 6.3 per cent in 2017, and may affect the profit growth of upstream industrial sectors.
Higher volatility driven by external factors
China's economy benefited from a strong export recovery in 2017. But a number of risks related to the external environment exist this year.
Volatility in global financial markets seems likely to rise, particularly if the Fed hikes rates faster than expected, and the ECB's monetary policy will also be in transition.
Besides, the US and China may see more trade friction this year as trade protectionism is on the rise. If there is a slowdown in external demand this year (which we do not expect), we think the government may consider loosening tight de-leveraging measures to support domestic demand.
Based on these investment themes, we like the IT/e-commerce, banks, healthcare, insurance and consumer staples sectors. Meanwhile, we hold a neutral view on the property sector. We are relatively cautious over the industrials sector.
- IT/e-commerce: Chinese e-commerce companies should benefit from the monetisation efforts of their non-current revenue sources. China's online retail market should continue to grow on a secular trend.
- Banks: Chinese large banks should see wider net interest margin as a result of the government's de-leveraging efforts which could lead to higher interest rates. The overall positive economic environment should cap the downside in the corporate balance sheet of their borrowers.
- Healthcare: The healthcare sector should benefit from the stronger demand for better medical services amid the rising household disposable income. The demand for healthcare product and services should continue to rise with ageing population.
- Insurance: China's insurance sector should see continual and stable growth in 2018, driven by the rising demand for insurance protection from consumer as well as the expansion of distribution capacity.
- Consumer staples: China's consumer staples should benefit from the higher CPI in China this year. Higher household income should drive the trend of premiumisation in consumer staples space.
- Property: We expect slower sales growth in Chinese property companies given the tight monetary environment and government's intensions to slow down property investment. But any significant price decline in China's property price is unlikely, in our view. Industry consolidation will be visible in China's property industry.
- Industrials: We are relatively cautious over China's industrial sector, due to the slowdown of infrastructure and property investments this year. The government has already slowed the approvals of many private-public-partnership infrastructure projects.
- The writer is chief investment officer, Asia Pacific, Deutsche Bank Wealth Management