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China: The short-term story

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2013 has so far seen mixed signals from China. Investors’ fears of a hard landing for the Chinese economy in 2012 have subsided but there are concerns over the state of the country’s banks. Amid the familiar consensus that China is a good long- term story, there are signs that now may be the time to invest in China.

The IMF World Economic Outlook update for January revised down its global growth forecast by 0.1 per cent to 3.5 per cent for 2013. However amidst this there was no change to expected growth in China of approximately 8 per cent for both 2013 and 2014.

According to the latest monthly survey from the Bank of America Merrill Lynch, investors’ fear of a hard landing in China has significantly reduced. In January, 15 per cent of investors believed there will be a hard landing, however this fell to approximately 10 per cent this month. China was also named in the survey as the most favoured market in emerging markets, with a net 50 per overweight, the highest since February 2012.

China’s trade and credit data, published this month, supports the upturn in the Chinese economy. Strong trading saw exports rise 25 per cent in January compared to the same month in 2012, with a trade surplus standing at $29bn. There was also a 29 per cent increase in imports in January and inflation remains steadily in check at 2 per cent.

Schroders head of global international equities Virginie Maisonneuve is optimistic about the impact of these figures for Chinese investment. She says: “All of this supports the case that China’s growth is on the right track. This is important not only for investors looking for stock ideas listed in China but, more importantly, for the global economy.”

However promising the signs of a recovery in China may be, there remains a common concern for fund managers and investors alike that China is a classic example of the economy not being reflective of the stockmarket.

Standard life global thematic strategist Frances Hudson takes this further by suggesting the companies listed first on the Chinese stockmarket, namely the big state-owned banks and industries, do not reflect what she sees as some of the best opportunities in the country.

She says: “The thing about emerging markets’ stock markets is you need to look at what lists first. In the case of China, these are state-owned enterprises and banks. There have been problems across China’s banks, state-owned energy companies and big state-owned industries. If you want to capture the best of the Chinese economy, I would not look there.”

One opportunity Hudson argues is overlooked is the giant Chinese internet web services company Baidu.com, which is not listed on the stock exchange.

Baidu was set up in 2000 and currently operates as a search engine for websites, audio files and images, along with an online encyclopedia and discussion forum.

Hudson says while Baidu is proving a success, investors should bear in mind the company’s potential may be inhibited by possible clashes between the Chinese Communist Party and Baidu’s business practices.

Hudson says opportunities can still be found in China if investors are selective. There are some Chinese companies in Standard Life’s Global Emerging Markets Equities fund, although Hudson is clear they remain at a “safe” distance from China. Elsewhere, they have emerging market debt in Chinese bonds and corporate bonds in Chinese company debt.

For JOHCM Emerging Markets Opportunities fund manager James Syme, Chinese internet stocks and technology companies are proving attractive as the fund seeks out cheap valuations and potential for growth.

The £71m JOHCM Emerging Markets Opportunities fund currently has its largest exposure to China at 27 per cent and its largest Chinese holding with Baidu. The fund holds 2.5 per cent with multi-national media company Naspers, which has 10 per cent of its assets in China, according to Syme.

Syme says these internet stocks are currently getting cheaper and cheaper in what he describes as a ‘huge de-rating’, as a direct result of the fact they are high growth companies that do not pay dividends. However he says they are expecting a sharp re-rating on these stocks as a knock-on from the US recovery which should see US yields go back up.

De-rating is a theme that Syme sees reflected in what he says is an unloved economy in China, arguing the country has suffered a “massive” de-rating in valuations to the point that the equity market is now almost back to where it was during the aftermath of the Lehman crisis.

However, Syme says he his happy to stay in the Chinese market, as his fund has been deliberately focusing on markets that have fallen out of favour in recent times as a way of ensuring growth.

He says: “While we have seen huge inflows into bonds and equities of South East Asia, Turkey and Latin American markets, we would rather be in some of the larger markets such as China, which have strong fundamentals and will be left unaffected if that foreign capital tide were to turn. This way, growth will continue to come through and our valuations are protected.”

Syme also points to signs of significant growth from a brand of low-end Chinese smartphones in emerging markets. The JOHCM Global Emerging Markets Opportunities fund has a 2.4 per cent holing in Lenovo, a China-based PC company. Syme says: “Lenovo was previously known as a PC company, but it is now set to be the world’s biggest seller of smartphones this year.”

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Bestinvest managing director of business development and communications Jason Hollands (pictured) summarises China as “a tricky call”.

Hollands says fears for the country’s hard landing have definitely eased, due to “more government infrastructure spending which should support the Chinese economic in the near term”.

With this in mind, Hollands says Chinese shares are looking optically cheap. Nevertheless, he still encourages investors to avoid piling back into China and approach it instead with a degree of caution.

He says: “China’s economy is fundamentally imbalanced, with too much reliance on infrastructure projects and exports, and it faces many formidable challenges including rooting out corruption and addressing growing social and political unrest.”

For most investors, Hollands says a China specific fund is too risky. Currently, Bestinvest prefer broader Asian funds such as the Schroders Asian Alpha Plus, which Hollands argues are able to provide access both to mainland China and Hong Kong listed stocks.

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