China Market Outlook from Value Partners Co-CIO Louis SO

08-11-2019

Global purchasing managers’ index data, indicating the prevailing direction of manufacturing activities and economy, plunged below the alarming threshold of 50 to a seven-year low1. While industrial and economic data show signs of deterioration, financial policymakers globally are inching to further more policy easing and stimulus measures. Meanwhile, the near-term global economy is expected to remain under pressure amid prolonged trade talks between US and China.

However, a wide range of opportunities is still available out there, in particular in China. Our Co-Chief Investment Officer Mr. Louis SO presents our latest views on the Chinese market. He will also discuss the investment opportunities despite the economic and political headwinds.

 

  1. What indicators are you monitoring for broader global market and for Greater China space?

Globally, the additional liquidity, injected via the recent loosened monetary policy in the system, to a certain extent will help reduce the likelihood of a global recession in the coming year. We observe that investor sentiment, which is consisted of two macroeconomic factors throughout the year­ — Concerns on a sluggish global economy and uncertainties arising from trade disputes weighing on growth.

We believe the additional liquidity, injected in the system globally via the recent loosened monetary policy, will help reduce the likelihood of a global recession in the coming year.

For China, we also look into the scale and range of government support to the economy. The authorities have put in place a string of fiscal policies in support of economic development. For instance, the financial regulator did not further tighten controls to curb purchase in the real estate market. The resultant local debt growth has led to an expansion in total outstanding credit. Open market operations such as general and targeted cut of the reserve requirement ratio are also in the officials’ toolkit to use as and when appropriate.

Next, stock valuation is also one of the indicators we have been closely monitoring. As of the end of September, Hong Kong’s flagship stock benchmark Hang Seng Index has a current forward P/E ratio of about 10x2, approaching to a historical level previously seen during market crises. In comparison, MSCI China Index has a forward P/E ratio of roughly 12x3, in line with its historical average. Already priced in some global headwinds, corporates as a whole enjoy a stronger corporate earnings growth than those in neighboring countries and major developed markets globally. As at 10 October, the earnings growth of China’ A shares reached as high as 16.5%3, according to MSCI data.

For the above reasons, we remain positive on China’s economy outlook in the medium and long term.

 

  1. Against this backdrop, where does Value Partners identify investment ideas?

Sectors that potentially benefit from China’s economic restructuring are in favor as they likely outperform the overall GDP growth in the next 5-10 years. Adhere to our fundamental investment approach which focuses on bottom-up company research and prudent stock selection, Value Partners has uncovered five investment themes over the medium to longer term.

a) Consumption upgrade: Consumption has become the backbone of the future economic development, on the back of a rapid expansion of medium-to-high income class. The number of people earning an annual salary of over RMB200,000 is expected to reach a population of 11 million by 20254. This cohort of Chinese nationals generally prefers a better quality of life. In addition, the individual saving level tops most of the countries in the world5, but consumption accounts for a small proportion of the GDP when compared with developed countries like Japan and the US5. We expect China’s saving rate to gradually decrease in the next few years due to an aging population, unlocking a substantial room for consumption growth. Furthermore, as the consumer sectors enter an era of product innovation, consumption demand triggered by novel products will enable companies to expand market share and boost profitability6.

b) 5G related industries: 5G technology brings an unprecedented scale of infrastructure investment, the scale of which will be two to three times as much as that of 4G technology7. Meanwhile, 5G network can initiate an application and development in the related innovative areas like smart city and cloud gaming. According to some industry reports, the number of devices with Internet access will increase from the current 9.1 billion to 1 billion in the 5G era8, resulting in a rapid growing demand in hardware devices. The technology names in the relevant sub-sector listed in Hong Kong and Taiwan are in an attractive range of valuation9.

c) Private higher education: The tailwind for the industry is essentially twofold-robust demand but inadequate supply. Every year, approximately 9.5 million10 candidates sit for the National College Entrance Examination, or commonly known as the gaokao. Only 7.5 million10 of them are able to land a place in tertiary education, implying a supply gap to fill for the remaining two million10. Secondly, the tuition fees for higher education have room for increase. The current average annual tuition among private universities is only around RMB12,000, whereas it can go as expensive as RMB140,000 in the US10. Thus, tuition is expected to ride on an annual growth of around 5% over the next 5 to 10 years10.

d) Pharmaceutical sector: The country’s pharmaceutical and healthcare sectors pose high growth potentials in the medium to long term, driven by a growing aging population. At the moment, the nation’s pharmaceutical names are in a reasonable valuation range. Innovative market leaders with research and development capability are less affected by the official central procurement scheme and are able to expand their market shares amid competition, representing a significant investment value.

e) Online services: The service industry has room for growth as it contributes much less economy in the context of China, comparing with the developed market average11. Besides, the country’s online service platforms are just taking their first strike, and the latest surveys show that the habit of making booking via online platforms is only beginning to gain popularity12. The intrinsic value of these market leaders remains underestimated.

Sources:
1. Bloomberg, 30 September 2019
2. Hang Seng Index, 30 September 2019
3. MSCI, 16 October 2019
4. CEIC, Morgan Stanley, Citi Research Jan 2019, EIU, CICC Research, January 2017
5. CEIC, September 2019
6. Bloomberg, Euromonitor, December 2019
7. IDC, CICC Research, August 2019
8. GSMA Intelligence, December 2018
9. Bloomberg, September 2019
10. CSCI Research, Frost and Sullivan, December 2017
11. Wind, National Statistics, December 2018
12. iRearch, December 2018

The views expressed are the views of Value Partners Hong Kong Limited only and are subject to change based on market and other conditions. The information provided does not constitute investment advice and it should not be relied on as such. All material has been obtained from sources believed to be reliable as of the date of presentation, but its accuracy is not guaranteed. This material contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.

This material has not been reviewed by the Securities and Futures Commission in Hong Kong. Issuer: Value Partners Hong Kong Limited.