Will the Year of the Pig see a turn in Chinese fortunes?

The coming days will see the annual mass exodus of hundreds of millions of Chinese urban workers and students from Chinese cities back to their villages for the Lunar New Year holidays. This is the largest mass migration of people on Earth and is estimated to involve nearly 3 billion journeys. Businesses can shut for up to 3 weeks during the festivities – meaning many companies have to be acutely aware of their supply chains to ensure suffcient stock is held.

Tuesday (5^th Feb) will usher in the Chinese New Year - the year of the Pig – according to the Chinese zodiac. If you are born in this year it is said you are energetic, enthusiastic and let yourself enjoy life. However, pigs are not the best with money and while, according to Chinese mythology, the sign of pig is regarded as bringing luck to others, this does not necessarily apply to those born under the sign of the pig themselves. It is said that pigs can be gullible, trusting and therefore easily scammed - attributes the Chinese authorities will surely not want in their negotiating team which has just arrived in Washington DC for critical trade talks.

This year Chinese New Year takes place against the backdrop of a more challenging period for China, the world’s largest nation with a population of 1.4 billion. While the Chinese economy has ascended to become the second largest economy on the globe, as measured by GDP, the data coming out of China over several months has been disappointing. Official economic growth figures, which many western observers are sceptical of, are expected to show GDP growth of 6.5% last year, down from 6.9% in 2017. While these figures are still high compared to developed markets, this is a long way below the double-digit growth rates that China posted consistently before 2008, fuelled by a rapid expansion of credit. The recent slowdown is in large part down to actions taken by zealous Chinese authorities at the end of 2017 to reign in credit growth - with total debt having grown to 260% of GDP.

Another source of uncertainty in the lead up to the Year of the Pig has, of course, been the escalating trade war with the US, as President Trump has pursued a combative, “America First” approach to tackling trade imbalances, slapping tariffs on an extensive list of Chinese imports to the US. Trade talks between the US and China are taking place this week to try and reach an accommodation, with the US threatening to further increase tariffs on Chinese imports estimated to be worth $200 billion from 10% to 25% if a deal is not reached by 1 March.

Unsurprisingly, Chinese equity markets endured a tumultuous 2018, a year which saw stock markets across the globe battered by fears about the future outlook for global growth. The Shanghai Composite Index of companies listed on China’s domestic markets slumped -28.5% in capital terms, significantly lagging both the MSCI World Index of developed market shares and the MSCI Emerging Markets Index in which China is the biggest constituent. These latter markets respectively declined by -10.4% and -16.6% in capital terms over 2018 (all returns measured in Dollars).

So is it time to give China a wide berth?

While the trade dispute with the US remains a headwind and source of uncertainty, there are signs that Chinese economy is starting to stabilise, one of which is rising house prices. Importantly, the Chinese authorities have taken a number of steps to stimulate the economy, which are targeted in nature than merely easing lending conditions. These include income tax cuts and a lowering of VAT which should benefit domestic consumption, as well as corporate tax cuts and capital spending programmes. The People’s Bank of China also injected 1.14 trillion of net liquidity into the financial markets in mid-January, estimated to the largest it has ever made, and has announced plans to cut the reserve rate further. These measures will take time to feed through to the real economy, but are undoubtedly supportive to the economy.

A further factor that supports the case of China, and emerging markets more generally, are signs that the US Federal Reserve Bank is shifting to a more dovish stance on the future pace on interest rate rises. This follows the market turbulence at the end of 2018 and signs that US growth is moderating after a marathon run of expansion. This is leading to somet softening in the Dollar, stemming a period of it strengthening against other currencies. A strong Dollar and rising US interest rates has been a particular source of pain for emerging markets, leading to international investors withdrawing capital and ploughing back into Dollar assets. It has also hurt those countries and companies that borrowed heavily in US Dollars during the years of ultra-low interest rates, as the costs of servicing interest payments in Dollars has risen sharply. A weaker Dollar is therefore broadly good news for emerging markets.

Another reason for optimism is current valuation levels. Both Chinese equities and emerging market shares generally, are inexpensive compared to their longer-term averages and their developed market rivals, with the MSCI Emerging Markets Index trading on around 12 times earnings. In fact Emerging Markets are the standout value opportunity at the moment and it is notable that over the last quarter they have significantly outperformed developed market shares again.

In conclusion, while the macro-eonomic headlines may remain negative in the near term (pending a breakthrough in US-China trade talks), at these valuation levels China and the wider emerging market universe should not be ignored but rehabilitated after a brusing 2018. With the prospect of stimulus measures feeding through to improve the economic outlook over the coming year, the Year of the Pig could well provide an opportunity for those investors who are prepared to take the plunge and buy currently unloved emerging market or Asia Pacific funds which include China exposure. At Bestinvest we believe most investors should do this through the prism of broader Asian or Emerging Market funds, rather than specialist funds solely focused on China, to mitigate some of the risks.

Bestinvest’s top picks here include (further analysis available by clicking on the links) :

• Schroder Asian Total Return Investment Company (25% China, 29.1% Hong Kong). This is a UK-listed investment company,
• Schroder Asian Alpha Plus (22.6% China exposure and 24.4% Hong Kong)
• Fidelity Emerging Markets W (16.9% China, 9.4% Hong Kong)
• First State Asia Focus B (13.4% China, 14.1% Hong Kong)

Important information:

The value of investments, and any income derived from them, can go down as well as up and you may get back less than you originally invested. This press release does not constitute personal advice. If you are unsure about the suitability of any investment, you should seek professional advice. Past performance is not a guide to future performance.