“China’s glass is half full – we are drinking!”
As the first quarter draws to a close, markets are filled with civil wars, riots and revolutions and the latest tragedy in Japan, a situation which continues to remain fluid. However, given the alarming frequency of these events, the performance of global markets has been extremely impressive with most in positive territory year-to-date, whilst the volatility index is headed back to cycle lows and sentiment is broadly bullish.
Craig Farley, Investment Manager, Asian Equities, Ashburton says “ At the beginning of 2011, Ashburton’s view on Asia was that reasonable equity returns could be achieved this year but that the fragile state of the global economy would lead to a difficult and testing market environment.”
The standard argument for avoiding China in favour of emerging market peers or the ultra expansionary policy-fuelled Western markets has been that China is in ‘tightening mode’. History shows us it has rarely paid to bet against Beijing and this cycle has supported that argument as the Party has attempted to rein monetary policy back in to pre-stimulus levels. Inflation, property and loan growth data all suggest that we are approaching the end of the cycle if we haven’t already, whilst valuation support and recent announcements from Beijing provide added comfort.
“Like it or not, China remains a policy-driven market. Comments over the past six months from various Party officials have confirmed Beijing’s stance that fighting inflation and managing inflation expectations remain top priorities. We have argued for some time now that we expect CPI inflation to peak in the first half of this year and we see nothing in recent figures to change that view. Further reserve requirement ratio rises cannot be ruled out but these are being utilised to mop up excess liquidity (accumulation of foreign exchange reserves) but do not constitute monetary ‘tightening’. A structurally higher level of inflation is to be expected due to greater demand stemming from the country’s rapidly increasing wealth and consuming middle class, but this is not a cause for concern,” says Farley.
According to Ashburton, attaining a short and sharp feel for China’s stock market performance can often be achieved by looking at the property sector – the correlation is nearly 90%. Residential property prices continued to rise in February amid policy pressure, but at a slowing rate to last year. Strong underlying fundamental demand, double-digit income increases and low homeowner leverage all reflect milder growth, and the underlying premise that Beijing will not crash the market remains.
The unwritten contract of rule between the CCP and the Chinese people that was ‘entered into’ post Tiananmen Square - increased prosperity and living standards for all in exchange for a one-party system - necessitates a buoyant market, even if it does lead to isolated instances of gross capital misallocation. Government policies in the form of investment restrictions and property taxes are now having a major impact on speculative demand, and an abundant supply of residential and social housing is coming on-stream this year.
“Property transactions are approaching 2008 lows whilst developers are less flexible given their own balance sheet limitations, therefore we expect clearing prices to happen sooner rather than later. In terms of overall monetary policy, jitters abounded at the latest reading of M2 growth (+15.7% in February versus a 16% government target) yet this only confirms to us that normalisation from the expansionary stimulus policies of 2008/9 is nearing completion. Whilst we will see a slow down from last year, conditions will remain mildly accommodative,” adds Farley.
Loans outstanding, fixed asset investment and infrastructure investment have all returned to ‘pre-stimulus’ levels as Beijing has squeezed the brake-pads. Indeed, the implementation of the differentiated RRR (reserve requirement ratio) has enforced further constraint on lending and tightened liquidity, resulting in much stricter compliance with stated government levels, a very positive development.
Several other factors also deserve a mention. The 11th China National People’s Congress has recently concluded with a clear mandate that targeted economic growth for the next five years will be 7%. The number itself is irrelevant, as no doubt this will be exceeded, but the manner in which it has been accepted by the market is pleasing – not so long ago, anything short of the ‘magic 8% figure’ needed to ensure employment (and by extension social stability) would have been met with consternation.
At the market level, analysts have not been shy to downgrade forecasts over the past 12 months and with consensus numbers now expecting somewhere in the region of 12-13% EPS growth for 2011, upside risk across selective sectors is achievable.
“We are also impressed with the A-share market action which has now been outperforming Asia ex-Japan in dollar terms for the past two months. We believe, on a risk-reward basis, that China is a very attractive investment proposition at current levels given the confluence of positives that have developed over the past month. Ashburton has taken additional exposure in selective oil and gas and industrial machinery stocks, and we have taken on property exposure (with a view to adding further in due course)” concludes Farley.
About Ashburton
Ashburton, the asset management arm of FirstRand International Wealth Management Holdings Limited, is based in Jersey, the largest of the Channel Islands. Ashburton is an active investment manager, delivering a focused range of products to intermediaries, institutional investors and private clients.
Their distinctive investment philosophy is built on a long tradition of providing consistent returns and superior client service. They apply an active and unconstrained methodology throughout their range of funds and across multiple asset classes. Ashburton's team of investment professionals embraces the freedom of thought and capacity for bold and insightful action that has enabled them to nurture and build wealth for clients for more than a quarter of a century. Ashburton is headquartered in Jersey (Channel Islands), with representative offices in Cape Town, Johannesburg and London.
