As the powerhouse of Asia, what happens in China dictates the tone for the rest of the region. So, what's in store for 2014? Fidelity's Dale Nicholls offers his predictions.
As the third plenary highlighted, reform is top of the agenda for both the government and investors.
A key overriding message to come through is that the new leadership wants more emphasis on using market forces to determine pricing of goods and services and allocation of resources. While private enterprise is already the key driver of the economy, this will only support further opportunity for such companies to grow.
There was also a clear indication we will start to see reform programmes over the coming years for state-owned enterprises, the financial system, land rights and the fiscal structure – and we can also expect more focus on the environment and improved social welfare.
China in your hand
I am particularly interested in expected reform in rural land rights and the hukou, or household registration reform, which should significantly improve the rights and benefits of the country’s 230 million or so migrant workers.
Such reforms should clearly provide a positive backdrop for further growth in consumption. It should also greatly help those companies reliant on migrant workers in the form of lower worker attrition.
The exact timing for the implementation of some of these reforms is still unclear. What is clear is that President Xi has significantly consolidated his power, which bodes well for relatively speedy execution.
In any case, from an investment perspective, I maintain my long-term view that investments related to increased personal wealth and associated lifestyle changes across all manner of industries will be a major theme in China.
Increased consumption, the move from offline to online shopping for goods and services and demand for an improved lifestyle – better healthcare and less pollution – will continue to be at the forefront of investors’ minds, and there are some excellent Chinese companies operating in these industries.
I particularly like some of the private companies in this space which are managed by high quality entrepreneurs that have had to innovate to create the substantial positions they have in such a huge market.
But while private companies continue to gain prominence, should state-owned enterprises be ignored? They are considered large, cumbersome, inefficient entities used by the state to control strategic industries. While that is in part true, there are some very good state-owned enterprises.
Looking forward, I think the increased focus on private participation in the economy and pricing deregulation in areas such as energy and resources will help encourage some of the better managed state-owned enterprises to become more lean and profitable operations.
They already have experience in their industry, the right contacts and brand awareness within China and, if steered in the right direction, some of these could be excellent investments. Also, many are well out of favour so valuations look compelling.
So, what about the economy? Recent data shows things are stabilising, if not turning upwards. I still believe we are moving into a period of lower but more balanced growth, with consumption taking over as the main driver from investment and exports.
This shift is healthy and I would become more concerned if we saw a shift back to investment-led growth, particularly if it relies on continued strong expansion in credit. The growth in credit we have seen, particularly in the last two years, has been significant and the impact of potential non-performing loans (NPLs) on the financial system needs to be monitored closely.
Even with slowing growth, the fact remains that growth levels are likely to remain very attractive in a global context. This is a positive backdrop for companies to grow, especially for those in consumption-related areas. However, we also need to be focused on industrials set to benefit from some of the government’s policy initiatives.
We know the environment will remain a major focus and there are many interesting ideas set to benefit, including those in the alternative energy space. Deregulation of important industries such as the railway system, where ticket prices have not been increased since 1996, could also be something to consider.
Some of the more cyclical areas of the market also need to be monitored given improving supply/demand dynamics. Given my concerns about rising NPLs in the system, I remain cautious on many of the state-owned enterprises in the financials sector for now. In addition to concerns over credit quality, I think investors need to watch out for interest rate deregulation which could significantly lower net interest margins.
This leads me on to the risks of investing in China; whether in the form of regulatory, financial or corporate governance risk. These require detailed analysis and constant company visits to ensure they are understood. Looking at valuations across a range of sectors, which in many cases are near historical lows, it does seem many of these risks are priced in.
Overall, I am confident on China’s outlook and while ‘new’ China forms the backbone of areas of investment for me, I think a balanced view on previously unloved areas, such as state-owned enterprises and more mature industries, must also be considered.
I remain excited about the opportunities that come from a large, under-covered market undergoing significant change and supported by a solid growth backdrop.
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