Nichols, who took over as manager of the Fidelity China Special Situations Trust from Anthony Bolton in April 2014, said in the outlook section of the Trust’s half year results that, despite strong earnings growth over the last few years, the Chinese market is currently trading on a price:earnings ratio of 9.5x, compared to the S&P 500’s current P:E of 18x.
“I am expecting companies in the portfolio to increase earnings by over 20% in the coming year, and at some point this is expected to be reflected in stock performance,” he said.
According to Nicholls, the reason for this expectation is that, while economic growth is expected to moderate in China, it is likely to remain at an “enviable rate in a global context” but, perhaps more importantly, the government is undergoing significant reforms and is focused on rebalancing the economy away from investment and net exports and to consumption.
“The market sometimes gets so engrossed in headline grabbing numbers such as GDP and property prices that they are possibly missing the real long-term opportunities.
However, Nicholls did sound a few notes of caution as well.
“It is well documented that the Government wants to drive a structural change in its economic model from one that is reliant on investment and exports to one driven by consumption. Due to this structural shift we should expect economic growth to fall further from the heady days of annual double digit growth,” he said.
He added: that while such a move should be welcomed as consumer-driven growth is less volatile and more sustainable, it is important to note that credit growth has supported much of the rise in investment.
“This is clearly not sustainable and could lead to issues for the financial system in the future,” he added.
“Debt levels in China have rapidly expanded in the last five years, taking it from around 120% of GDP to current estimates of around 250%. History teaches us that such expansions usually end in significant non-performing assets, particularly in areas where the poor investment has been most severe.”
