Government figures revealed that the world’s second largest economy expanded by 7.4% year-on-year during the third quarter, down from 7.6% in the second quarter and at its slowest pace seen for three years.
Despite growth dropping below the official 7.5% target, other economic indicators offered more positive news. Chinese industrial production grew 9.2%year-on-year in September, up from 8.9% in the previous month, while fixed asset investment and retail sales also edged up.
These figures were taken as an indication that the country’s slowdown is coming to an end and raised hopes that it will avoid a so-called hard landing. But months of speculation over the health of the Chinese economy has damaged investor sentiment and opened up questions on how to allocate to the economic powerhouse and those assets linked its growth.
China’s growth in perspective
Gary Potter, co-head of Thames River Multi Capital, said much of the debate about Chinese growth focuses on the wrong issues and this misunderstanding has pushed investors away from the country.
Potter commented: “The fact that China’s economy is slowing should not come as a surprise to anybody.” Chinese authorities have discussed in successive five-year plans how the headline rate of growth would “inevitably” slow as the economy matures, he noted.
He argued that looking at the Chinese economy in terms of a hard or soft landing is “too simplistic”, given the sheer scale of its economy and the wide differences between industries and geographical areas. Also, the country is approaching a change in leadership, which is typically preceded by a slowdown but followed by an increase in spending.
In any case, the manager argued that a slowdown in the headline rate of growth should not be considered as purely negative when the overall size of the economy is taken into account.
“If your $10trn economy grows at 10%, you’re adding $1trn to the economic size of your nation. If your $45trn economy – which China is around at the moment – is growing at 7%, you’re adding about $3trn to the economy,” Potter said.
“The amount of job creation, per capita improvement, urbanisation and better standards of living will be stronger in a bigger economy than a lesser economy but the growth rate might appear to be lower.”
Chinese markets set to improve?
HSBC Global Asset Management’s latest Investment Quarterly report predicted China will be able to maintain a healthy growth rate for the rest of the year, especially if further policy support is used. This bodes well for investment opportunities, the study said.
Philip Poole, the asset manager’s global head of macro and investment strategy, and Renee Chen, macro and investment strategist, highlighted Chinese equities and renminbi-denominated bonds as being clear winners if the Chinese economy maintained its high growth rate.
Chinese stocks have fallen over 2012 and the commentators say valuations look low, with forward price to earnings ratios and price-to-book values sitting well below the market’s historical averages. Meanwhile, the market for renminbi-denominated bonds continues to mature and is likely to attract greater numbers of companies looking to issue in an Asian currency for the first time.
Jupiter China Fund manager Philip Ehrmann said the country’s plans to rebalance its economy away from export and towards domestic consumption increases the longer-term investment case of certain sectors.
“Investors need to remember that the Chinese economy is still very much in the process of transitioning. This is a transition that has clearly begun, but will, I believe, take much of the next five to ten years to play out,” Ehrmann said.
“For the Jupiter China Fund, it means we still favour companies that will be beneficiaries of the rebalancing towards domestic consumption.”
Ehrmann’s largest holding is Tencent, which offers online services such as social networks and multiplayer games to the Chinese market. The fund also has 13.3% of its £157m portfolio in consumer services and 8.3% in consumer goods.
Asset allocators will shift
Thames River’s Potter expects to see asset allocators channel more money towards Chinese equities as worries about the health of economy begin to abate, saying: “A number of fund managers are getting quite optimistic from here on Chinese equities.”
“They have devalued to the point that they are regarded as attractive. There is definitely, in light of market underperformance and devaluation, quite lot of excitement building on China.”
Although Thames River’s multi-manager funds have never invested in China-specific funds, Potter and co-manager Rob Burdett last week increased their overweight to Asia.
“We think Asia is quite an interesting place and by allocating more there, we will naturally be having a bit more in China,” Potter said.
“Although we do not go out and buy Chinese equities ourselves, maybe now is not a bad time to be adding to China if you are that specific in your allocation.”
Impact on global assets
HSBC’s Poole and Chen pointed out that strong Chinese growth would have a significant impact on a number of global asset classes.
“If China is successful in engineering a soft landing, risk assets (equities, corporate bonds and high-yielding currencies which continue to be highly correlated) are likely to benefit given that such an outcome would probably improve global risk appetite,” they wrote.
Schroders economist James Bilson agreed that risk assets, especially those highly geared towards Chinese growth such as the German Dax, emerging market equities and commodity currencies like the Australian dollar, will benefit from improved growth.
However, he warned that the outlook to Chinese growth is not completely free from risk. “Over the coming year … risks to growth remain; primarily through further deterioration in either the eurozone, the US fiscal cliff, or another downturn in the domestic housing market without the necessary policy support.”
