There are plenty of reasons not to believe in a Chinese recovery. Indicators suggest that the economy is in big trouble – freight volumes and energy consumption are in in negative territory and anyone with exposure to mining stocks knows that demand for commodities has stalled.
China will be the biggest economy in the world by 2020
But Dale Nicholls, manager of the Fidelity Special Situations fund said that there were also key markers to suggest that while the economy was slowing, the stock market was set to rise.
“Investors should make the distinction between the old economy and the new economy,” he said, speaking at a press briefing this week. “The services sector looks good, retail sales are up – including e-commerce and the consumption story remains strong.”
Nicholls admits that the headline GDP growth figure of 6.8% is probably inaccurate, he says it does not actually matter what the exact figure is.
“I am not a GDP bull. We know that 6.8% is probably not the real growth figure, but you can get a sense of the rough range from various data points,” he said. “Transparency is a problem, but the Bank of China is getting better – look at the recent communication from governor Zhou Xiaochuan.”
Nicholls said that the economic slowdown would hurt the stock market but only if you were exposed to those old economy companies – steel, chemicals, construction. He prefers companies centred on the new economy; IT stocks, fabric suppliers, alternative energy, telecoms and disruptive technology.
On the whole he prefers private companies to state owned enterprises (SOEs), although he has made an exception for CITIC Telecom, which owns 35,000 metres of fibre optic cable throughout China – and has “great potential” according to Nicholls. Questioned whether he trusted the majority stakeholder he admitted that corporate governance was a challenge, but said that was true of all emerging market investing.
Is China Heading for a Lehman’s Like Banking Crisis?
One area Nicholls will not be tempted into is Chinese banks, warning that debt had doubled in recent years, leaving what he called non-performing loans on the books. Nicholls said that the problem of bad loans was “ahead of us” and he expected stock markets to take a further hit as the debt unravelled.
“The potential for an out and out crisis akin to that in 2008 is low. China has good deposit support, if anything Chinese people save too much, and the largest shareholder – the state – has proved it has control,” he said. “Liquidity is not an issue as it was in developed markets during the Western credit crisis.”
But Nicholls did admit there is risk of a Japan-style financial stalemate, where bad debt just sat on the books and crippled the chances of new lending.
Buying While the Market is Deflated
Despite Nicholls’ optimism, China remains out of favour with investors, scared off by slowing economic growth, rising debt and currency concerns.
“You do have areas of the market which are strongly declining, but they pull down the whole market. It is as cheap as it was in the depths of the global recession – even if you strip out the energy and banking stocks, which I would not hold, this is still a great time to buy,” he said.
Nicholls is so bullish on Chinese equities that he has upped the gearing on the trust to record levels – borrowing money to invest further into the market. He is also keen to invest his own cash alongside shareholders, but says that he is restricted from buying while the board is trading.
“Whatever the real economic growth numbers are, consumption is going to remain a big story for those investing in China, as the middle class emerges. China will be the biggest economy in the world by 2020, it makes up 13% of global GDP but only 3% of global markets,” he said. “China is the biggest overweight in my broader region portfolios, on valuation, on growth potential – it’s compelling.”
