- Chinese New Year brings some hopes on the trade front, as some details are emerging on progress with the negotiations. We expect some sort of conditional deal to be reached; however, uncertainty regarding the bilateral negotiations is likely to persist, particularly because at the core of the discussion there are structural issues such as intellectual property protection, and subsidies and SOEs (Stated-Owned Enterprises), which are not likely to be fully addressed in the short term.
- We believe China does not represent a serious risk to global growth. On the economic front, data are mixed: the slowdown accompanying the transformation of the economy in climbing the value chain and moving away from investments towards consumption is so far under control. China’s policymakers seem determined to use the cyclical policy supports to prevent an economic hard-landing.
- Regarding monetary policy, there is a clear easing bias, and plenty of margin for further RRR (reserve requirement ratio) cuts, or for benchmark bank rate cuts if necessary. On fiscal policy, there has been a turnaround of the fiscal deficit since Q3 and we expect to see more supportive measures in the future.
- These potential improvements on the macro side do not seem sufficiently reflected in the Chinese equity market, which is discounting a negative scenario and offers quite inexpensive valuations. Considering the Fed’s dovish stance, the signs of bottoming revisions, and the improved sentiment on emerging markets (EM), we believe that 1H19 could provide good entry points for investors.
- In our view, the main drivers of the market currently are currency evolution and the developments in trade negotiations which in turn have an effect on the currency. Equity market could benefit from a stable/stronger yuan, which we could expect if negotiations succeed.
- Among Chinese markets, we have a preference for the HSCEI (Hang Seng China Enterprises Index) which looks even cheaper than the MSCI China, thanks to its higher exposure to financials that performed poorly last year. In terms of fundamentals, the high return on equity and high dividend yield could provide good value. Regarding stock selection, we remain positive on the most domestic-oriented companies, such as internet companies, oil, pharma, consumer staples and property, although in a very selective way for the last two sectors. Telecom, utilities, auto remain the least favourite sectors.
- The main risk in the short term relates to the ongoing weakness in the economic cycle. The ongoing reporting season (still at its beginning) will be key to assessing how fast the deceleration is unfolding.
- There are long-term challenges linked to the extremely high level of debt in the economy and other structural issues. We are sceptical about any dramatic positive outcome in this regard in the short term, but would be more constructive in the medium to long term if China could continue to push its structural reforms and openings, as has already been the case.
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