Tips for assessing Chinese stocks

Slower global growth and U.S.-China trade tensions have investors primed for a rockier 2019. But instead of bracing for the shock that headlines suggest could be on the way, forward-looking investors with a long view stand to benefit, experts say. Chinese equities, highly volatile last year, provide opportunity for those who know what to look for.

While declines in Chinese equity prices have been largely driven by investor sentiment, Andrew Mattock, portfolio manager at Matthews Asia, says in a 2019 outlook report that he looks past sentiment to what’s happening on the ground.

What’s happening, for starters, is a growing rate of consumption, including a 27% increase in sales on China’s biggest day for retail spending in November 2018—its version of Black Friday in the U.S. Consumer spending patterns, especially in discretionary areas such as electronics, entertainment and clothing, hint at where China’s economy is heading, Mattock says in the report.

Consumption is expected to grow as underserved cities with relatively smaller populations—in the range of 150,000 to 3 million people—are targeted by businesses and as jobs and incomes grow. Such cities represent “pent-up demand for everything from dating apps to Indian food restaurants,” Mattock says. Companies that tap into growing consumer spending will thus increase earnings.

Further, valuations should improve along with company quality as government reforms foster a healthier marketplace. Equity prices could quickly rebound if a trade resolution occurs, Mattock says. And, even in the absence of a resolution, “any pickup in earnings growth could nudge investors off the sidelines and back into the market,” he says.

Other managers also look beyond macroeconomic trends and geopolitics as they consider Chinese equity picks.

A blogpost by Penderfund Capital Management’s Felix Narhi and Sharon Wang says success in investing is often due to tailwinds investors don’t initially appreciate. They provide an example by describing their recent trip to China. Narhi is chief investment officer and portfolio manager at Penderfund, and Wang is senior investment analyst.

Most of the companies they visited were online companies, including Penderfund holdings Baidu, a search engine, and JD.com, an e-commerce company (both headquartered in Beijing). While the IMF expects the Chinese economy to grow at a pace of 6.2% this year—the slowest since 1990—Narhi and Wang say companies like Baidu and JD.com are on track for secular growth, as were FAANGs when the U.S. economy was hit hard in 2008.

“Secular growth stories tend to continue to climb, albeit at a slower pace, even when economies go through periods of slowdown,” say Narhi and Wang in the blogpost.

Further, state favouritism nurtures homegrown tech giants. In particular, state funding for artificial intelligence offers an advantage to such firms as Baidu, Alibaba and Tencent.

“We like it when our investees have […] unfair advantages, i.e., competitive moats,” Narhi and Wang say.

Another positive: China shows an eagerness to embrace change and new technologies. “In many industries, China has already moved well beyond its historical copycat narrative and has taken the lead, arguably innovating at a faster pace than many Western tech peers,” Narhi and Wang say. Areas of innovation include digital payments, e-commerce, interactive gaming revenue and online grocery delivery.

Further, fierce competition within technology pushes China’s “internet elephants” to expand outside their traditional core businesses, like Baidu’s expansion into artificial intelligence development. Thus, investors should consider what’s nascent today but could expand within a few years. Say Narhi and Wang: “We are watching a number of Chinese companies with great interest.”

For more details, read the full Penderfund blogpost and the outlook from Matthews Asia.

Staff

The staff of Advisor.ca have been covering news for financial advisors since 1998.