With Chinese New Year now upon us, Gary Greenberg, Head of Emerging Markets at Hermes Investment Management, gives his views on China, and what lies ahead in the Year of the Rooster.
There had been hope that China would embark upon economic and legislative reforms by now, but so far the evidence is sparse. Therefore we believe that China is on an unsustainable track. Official credit growth is expected to slow down but in any case, at the current rate we believe that the credit to GDP ratio will be as high as 350% by 2020. This is less egregious than Turkey or Brazil because the majority of this debt is held domestically.
State-owned enterprise finances are improving because the authorities have been cutting supplies of steel and other basic materials by telling companies to halt production, which has resulted in a spike in prices for these materials. In the short term, we believe growth will continue at 6+% despite the declining property market. This is due to continued government spending on infrastructure, despite private investment stagnating. Also, credit growth and negative real rates keep liquidity high. Normally in this environment money would leak overseas but the authorities are working hard to plug any leaks so that they can manage the eventual economic slowdown, putting it off for at least another year.
Because of the excess domestic liquidity, a slower property market will continue to spur rotation, and retail money will go to equities, primarily A shares. The market’s valuation has gotten cheaper since last year. We are not expecting the MSCI China to re-rate upwards, despite the fact that A Shares are doing so, and therefore we think 2017 should be a calm year for the benchmark. One could make the argument for value stocks in China given they should continue to enjoy policy support, but investing based on government subsidies is a weak and shaky strategy. We expect 12% earnings growth this year and some currency depreciation, translating to a high single-digit return for the MSCI China, but a better return from A shares.