Morningstar's "Perspectives" series features investment insights from third-party contributors. Here, Andrew Graham, Portfolio Manager of the Martin Currie Asia Unconstrained Trust, gives his views on China.
According to the doomsayers, China’s economy is about to come crashing down to earth in a ‘hard landing’ – a severe slowdown, by any other name. But before we embrace these harbingers of gloom, it’s worth considering a few facts about the Chinese economy.
Firstly, it has been adjusting to a period of slower growth for some time – a process we have been monitoring closely for four or five years. China’s transition from manufacturing to a more consumption and innovation-driven economy was always likely to be bumpy, and we’re seeing signs of that now. While we don’t want to play down the risks that exist in China for investors in Asia, such as the property markets, and some bad loans on the balance sheets of banks, we don’t think a hard landing is on the cards.
Reforms Could be Key
Let’s consider China’s slowing growth in more detail. In the third quarter of 2015, China’s economy grew by 6.9%, broadly in line with the Chinese authorities’ expectations. While the pace of growth is more sedate, the Chinese economy is expanding – and at a much quicker rate than its developed-market peers.
Many people seem concerned that China’s growth rate has fallen below the ‘magic number’ of 7%. First bandied about some years ago, that number is likely to have come from the Chinese authorities’ own calculations of the growth needed to sustain employment and avoid social unrest. It also reflected the demand required to keep the economy running at capacity.
But times move on, and the Chinese economy today is much bigger than it was a decade ago. Consequently, the growth rate needed to sustain employment is much less than before. To our mind, if China’s economy was to hit the rocks, it would have happened before now – probably back in 2009.
Looking to the future, we see reforms as a much more significant factor to watch than growth levels. We’ve seen anti-corruption measures impact the economy in all sorts of sectors, from gaming to restaurants. And we are watching with interest to see how SOE reform may improve returns and lead to better capital allocation. In addition, China’s policymakers have both monetary and fiscal policy tools at their disposal to bolster the economy – tools we are confident they will use.
Earnings Not to be Ignored
One reason investors in Asia are so absorbed by China and its potential to hit the rocks, is the ramifications for the broader Asian region. But we see the challenges facing China as one of three factors driving sentiment in the Asian region.
Another hurdle facing investors is company earnings, a slew of which have been revised down in recent weeks, particularly in ASEAN-based companies. This is partly because of foreign exchange concerns, but also down to a trend we’ve seen since 2010 where analysts are brimful of optimism early in the year, before lowering their forecasts as the year progresses. As things stand, analysts currently expect earnings per share (EPS) in the region of 0.2% for 2015, before improving in 2016 and 2017.
We think a strong recovery might be optimistic, and view depressed earnings as a real challenge for investors in Asia.
US rates – the Other Overhang
The other factor we’ll be watching with interest is the US Federal Reserve, and the timing of policymakers’ first interest-rate hikes. We can see from previous market cycles, e.g. when rates were raised in 1994, 1999, and 2004, that tighter monetary policy prompted falls in the MSCI Asia index. Consequently, US monetary policy is likely to have a significant impact on both Asian stock and currency markets this time around too.
A Time of Opportunity
Of the three main factors troubling investors in Asia – US monetary policy, depressed earnings, and Chinese growth – we expect the first two themes to largely play out of their own accord with little evidence to refute their impact. However, we would reiterate that we think a severe economic slowdown in China is highly unlikely.
As investors, we tend to get excited when investor sentiment is poor, for example when earnings expectations have soured and risk appetite is depressed. That is the picture we see today, and it will hopefully bring some interesting investment opportunities in the months ahead.
This article is part of Morningstar’s Guide to Investing in Asia, where the 50 composite countries and their different cultural nuances may be hard to understand, but create fantastic opportunities for long-term investors.
