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China syndrome

10 MINUTES with Richard Wong

China is currently among the most divisive investment topics, with bulls hoping it drags the world through economic hardship and bears proclaiming a rapidly inflating bubble.

HSBC manager Richard Wong – who runs one of the world’s biggest China equity portfolios – is in the bull camp, dismissing bubble fears and the misconception that the country is export-led.

He says: “The word bubble suggests excessive or unsustainable valuations and with the market on a P/E ratio of 13 times, that is less than half the level of the 2007 peak.”

Wong is also keen to set the record straight on exports although China has recently become the world’s biggest exporter. He says: “If you look at Chinese GDP, exports only made up around 8 per cent in 2008, with 42 per cent from investment and 50 per cent from consumer spending.

“That shows the country s clearly not export dependent and if the Government can continue to stimulate those two main engines, China will comfortably be able to keeping growing at the 8 per cent target level.”

Wong also notes that China is a processing centre, importing 50 per cent of the raw materials to produce its exports, and strong rises on the import side signal that the other side of the equation is set to improve.

He is positive on the state’s efforts to keep the economy running via a $4tn rescue package- citing various tax cuts and consumer subsidies –
although he feels now is the right time to tone down this stimulus. He says: “Retail sales and fixed asset investment were both up last year, ith
loan growth also increasing 33 per cent, and although exports declined, the Government looks to achieve its target of 8 per cent GDP growth.

“Now the export numbers are also improving, as the last leg of recovery, politicians need to pull back on the stimulus to avoid overheating.There are obviously concerns about tighter credit but China has $2tn in FX reserves so is fully equipped to come back into the market if things
turn down again.”

Although China was up by 60 per cent last year, Wong says it still lagged the other three so-called Bric economies of Brazil, Russia and India and could therefore have some catching up to do.

Like many managers in the region, Wong tends to invest in China via the Hong Kong H-share market rather than domestic A-shares.

The domestic market only started in 1990 and is largely made up of small caps, with the top 50 stocks accounting for something like 90 per cent of the index.

Where companies are dual listed, Wong highlights a 37 per cent valuation premium for the A-shares in light of China’s captive investor base.

He says: “As the country relaxes controls on FX flows to the rest of the world, this valuation gap should narrow and domestic-listed will be more attractive.

“The qualified domestic institutional investor (QDII) program, which allowed eligible local banks, fundmanagement firms and insurers to invest in overseas securities, was starting to narrow the premium but the financial crisis brought this to a temporary halt.”

On Wong’s giant China equity portfolio, he has been overweight sectors, including domestic consumption and infrastructure, which have benefitted from the state’s liquidity injection.

Other key overweight bets are online gaming businesses and coal stocks – with the latter recovering as economic activity picks up – while
underweights include property and banks.

Looking forward, he believes the incremental increase in infrastructure spending may be levelling off and has started to pare back his positions.

Wong’s consumer plays remain in place, with the government rolling over many of its subsidies on cars and household appliances into 2010. He says: “China is obviously a huge country and the infrastructure spend will continue to improve interconnectivity, particularly as most of the population live on the east coast while the resources are in the west.”

Overall, he believes the government will maintain the size of existing projects but scale back new ones to adjust investment as economic
recovery has been stronger than expected.

Of the $4tn rescue package, around 37 per cent was earmarked for infrastructure, with 5 per cent for environmental improvement and 3.7 per cent for healthcare.

Wong says infrastructure as a theme will clearly have the biggest impact on the country over the shortest timeframe but expects more investment in improving the country’s social infrastructure to come through.

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